As interest rises, so go the money funds

They introduced millions of savers to the joys of high interest rates a few years ago and now, after dropping to almost 8 percent last year, money market mutual funds seem to be making a steady climb back.

As of mid-June, the seven-day average yield on money funds stood at 9.87 percent, according to Donoghue's Money Fund Report. But many of these funds are paying over 10 percent, some as high as 10.4 percent.

There have been numerous changes in money funds since their last heyday. Now, savers have a much wider variety of fund choices, there are more funds investing in US government securities, and tax-free funds have become the hottest part of the money fund scene.

Since Dec. 31 tax-free fund assets have increased by almost one-third, from $ 16.2 billion to $21.7 billion, reports the Donoghue Organization. This represents about one-third of the increase for all money funds, which have added

Of course, yields on the ''tax frees'' are lower, currently averaging 5.4 percent, but they are meant for upper-income taxpayers. The definition of what consitutes ''upper income,'' however, has been changing as more people find themselves in the 40 to 50 percent bracket. For a married couple filing a joint return, for example, an income of $45,000 or so will put them in the 40 percent bracket, where today's tax-free yields make sense. If both husband and wife are working, that $45,000 can come pretty quickly.

Marketing may be a big reason tax-free funds are selling so well. Three-inch high black letters in a newspaper ad screaming ''TAX FREE'' can catch a reader's attention. And for people living in states like New York, California, and Massachusetts, where money funds are offered free of federal and state tax, the words ''DOUBLE TAX FREE'' are also effective.

Before getting into one of the tax-free funds, however, carefully work out your taxable income situation -- that is, after all deductions, exemptions, and credits -- and see if the taxable funds aren't just as good for you, or maybe better.

Another type of fund enjoying high growth is the government-only fund. Regular money funds have a nearly flawless record of safety, so government-onlys are sometimes referred to as ''belt and suspenders'' funds. Because they invest in securities backed by the US government, they are considered safer than ordinary funds that buy a variety of bank notes, certificates of deposit, and commercial paper.

The yields on government-only funds are a fraction of a percent lower -- say, 9.2 to 9.6 percent -- but this may be worthwhile for people who like to err on the side of caution.

Fractions of a percentage point should not be the sole reason for selecting any variety of money fund. Since most of these funds make the same types of investments (depending on which of the three overall groups they are in), you should favor flexibility over yield. Look for a fund that lets you shift your money into another kind of mutual fund when the stock market decides to head up again and money market rates fall. Usually this can be done with a phone call as often as you like, though some funds will charge for transfers, limit the number of times you can switch, or both.

You can put your money in a company that does nothing but manage a money market fund, but it should have an exchange agreement with another fund company. You will probably find it more convenient and secure, however, to go into one that is part of a large fund ''family'' where you can move your money among several funds without leaving that company. In addition to US stocks, some of these firms have funds that invest in corporate and municipal bonds, precious metals, and stocks of overseas companies.

One thing to look for in a money fund now is ''average maturity.'' When interest rates are rising, as they are at present, the average maturity of the securities in a money fund portfolio should be short, say, 30 days or less. This way, the fund's managers can more quickly move into new higher-yielding securities as long as interest rates continue going up. When rates begin to fall again, these managers will lengthen their maturities, perhaps to 45 or 50 days, in order to hold on to high rates longer. For safety's sake, however, a fund should rarely go beyond 50 days, even when rates are declining.

If you want to keep track of the relative safety of various money funds, take a look at Money Fund Safety Ratings, a newsletter that ranks the funds from triple-A through D. The rankings are based on diversification, maturity, and quality of the funds' investments. Each fund listing also includes a phone number (usually toll-free) you can use to order a prospectus and application. You can get a free copy of the newsletter by writing Money Fund Safety Ratings, 3471 North Federal Highway, Fort Lauderdale, Fla. 33306. Credit union insurance

Many people have savings in credit unions around the country and would appreciate any information you may have on how they are insured. My federal credit union is insured by NCUA (National Credit Union Administration). What does the term ''federal credit union'' mean? Is the NCUA a government agency, or a private entity? -- G. H.

The NCUA is a government agency that regulates federally chartered credit unions, those that are eligible for the National Credit Union Share Insurance Fund. This fund's insurance is similar to that provided by the Federal Deposit Insurance Corporation and the Federal Savings and Loan Insurance Corporation in that it protects up to $100,000 of deposits. However, the fund has not been able to maintain as high an assets-to-deposits ratio because of the rapid growth of credit unions and because the fund is only 14 years old. Since 1970 the ratio at credit unions has never been higher than .32 percent, about one-third of 1 percent, compared with 1.3 percent at the FDIC and the FSLIC.

NCUA officials are not happy with this situation and are supporting a proposal in Congress to require member credit unions to pump $850 million into the fund, which would raise its ratio to 1.3 percent. Opponents of the proposal argue that some credit unions would leave the fund to avoid the extra fee. In the meantime, an NCUA spokeswoman says, ''No credit-union depositors have ever lost a penny within the insured limits, and we can draw on the Treasury if we have to, same as the FSLIC and the FDIC.''

If you would like a question considered for publication in this column, please send it to Moneywise, The Christian Science Monitor, One Norway Street, Boston, Mass. 02115. References to investments are not an endorsement or recommendation by this newspaper.