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Money funds tied to US bonds adding good yields to safety

Some people call it the ``belt-and-suspenders approach.'' They're referring to money market mutual funds that invest only in securities issued by the United States government -- particularly Treasury bills and federal agency bonds and notes that are paid for out of tax dollars. At a time when some people think interest rates have hit bottom and as more people become concerned about the safety of the nation's financial institutions, these ``government'' or ``government only'' mutual funds are gaining favor.

These mutual funds are also gaining on ``general purpose'' funds in the yield department. Until just a few months ago, investors in government-only funds earned one-half or one percentage point less in yield to investors than did investors in general funds that could buy a whole range of bank certificates and commercial paper, as well as government securities.

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But at present the average government-only money fund yield is only 0.07 of a point behind the general-purpose money market funds, says Connie Bugbee, who keeps statistics for the Donoghue Organization, which publishes newsletters on money funds. At the end of February, the general funds' average yield was 7.81 percent, compared with 7.74 percent for their government-oriented brethren, she said.

Although neither rate is particularly high, especially compared with the 9-plus percent rates available on bank certificates of deposit, they are expected to go up. And when they do, that's when more people get interested in the liquidity and flexibility of money market funds, including people who have never invested in them before, says William E. Donoghue, president of the Holliston, Mass., firm that bears his name.

Government-only money funds should not be confused with government-securities mutual funds. The latter invest in certificates from the Government National Mortgage Association, which have longer maturities than Treasury and federal agency notes. The net asset value on government-only money funds remains constant at one dollar. In Ginnie Mae funds, the NAV may be higher, but it can go up or down, which affects the value of your prinicpal.

One reason for the narrow difference in yields among government and general-purpose money funds is the huge federal deficit. As it grows and as prospects for a continuing deficit stretch out into the future, investors are demanding a higher return on Treasury debt. Treasury debt is still regarded as having no risk, though, so it will probably never pay a higher yield than commercial paper. But the money market can force the government to come very close to commercial rates, and has done so.

The closeness in yields means better returns for people who may be concerned about the safety of general-purpose money funds, even though the concern seems largely unfounded. In the history of money market funds, no investor has lost any prinicpal in them, and the few problems that funds have had came during their rapid growth of the late 1970s and early '80s. During that period, investors occasionally had difficulty reaching some fund representatives on the phone or getting applications or payments processed quickly. The funds have since geared up to handle the load.

One problem the general-purpose funds did not have to face during that period was the turmoil in the US banking system, which has caused numerous failures among banks and thrifts and has brought about numerous mergers. This partial loss of confidence in the banks has led some investors to shy away from funds that invest in bank securities. Most fund managers, however, take a very conservative approach toward the banks whose paper they buy, and if there is a hint of trouble, they get out.

Still, there is no security like the US government. Money market mutual funds that stick with Uncle Sam have grown from fewer than a dozen five or six years ago to more than 70 today.

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At Fidelity Investments in Boston, government funds are ``selling pretty well,'' says Ned Costello, marketing director. ``It's a combination of the fact that you're not giving up much in yield, combined with the `belt-and-suspenders' [safety seeking] attitude among investors.''

Within the overall category of government funds, there are some variations. Some funds invest only in securities issued directly by the US government, such as Treasury bills. These are as guaranteed as anything issued by the US government can be.

Then there are funds that invest in agencies carrying the ``full faith and credit'' of the US government, which means the securities do not come directly from the Treasury, but from an agency the government has promised to back up. Some of these agencies, however, technically do not carry the full backing of the US Treasury. The question, then, is: Would Congress let these agencies default on their debt? Most experts think the answer is no, which means there is no important difference among the various government-only funds.

In addition to appealing to investors who want extra safety, government-only funds can be useful to wealthy individuals or institutions that have more than $100,000 they want to park somewhere. With bank deposits insured up to $100,000, safety-conscious investors with more than this can either split their money among several banks or buy Treasury bills directly. Both options can be time-consuming and cumbersome.

But with a government-only fund, you have a portfolio of government securities that is professionally managed and fully guaranteed, no matter how much you put in. Still, some people who want to keep building margins of safety can use more than one fund if they have this much money. Since these fund accounts can be opened with a phone call, an application, and a check, the process of dealing with more than one fund is not complicated.

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. No personal replies can be given by mail or phone. References to investments are not an endorsement or recommendation by this newspaper.