Money Funds: Good Yield, Safety

INVESTORS use stock mutual funds when they are in gear to make money, but when they just want to park it, their spot of choice lately has been money-market funds.

Total money-fund assets leapt 23 percent in 1995, up from a 6 percent rise in 1994, reports IBC/Donoghue Inc., a financial services information firm in Ashland, Mass. This year, total assets, which include those of funds for both individual and institutional investors, stand at more than $800 billion.

Money-market funds continue to offer higher yields than bank savings products, fueling much of the inflows, market watchers say. Another impetus is the large inflows into mutual funds in general. That's because many investors hold some "cash" as well as money in stock and bond funds.

"I think everyone should have a percentage of their total portfolio in liquid assets, and I would consider a money market [fund] your cash reserves, or your liquid assets," says Michelle Smith, managing director of the Mutual Fund Education Alliance, a trade association of no-load fund companies in Kansas City, Mo.

When deciding whether or not to invest in these types of funds, here are some details to keep in mind:

Safety. Money funds are considered fairly safe, as they generally maintain their share price at $1. That means your principal does not rise or fall in value as it does with stock or bond mutual funds. Unlike bank deposits, however, money funds are not federally insured.

Different money funds have different objectives and levels of risk, so you should do some research to determine which one is right for you.

The three basic types of money-market funds are: (1) those that invest in only government securities and are considered the safest; (2) those that invest in some combination of commercial paper (IOUs from companies borrowing for a short time), bank certificates of deposit (CDs), and government securities - and which usually have a higher yield because the investments are somewhat riskier; and (3) those that invest in municipal securities and thus have a lower, but tax-free yield.

Time frame. Money-market funds are generally considered short-term investments. They are not appropriate for reaching long-term goals because your capital doesn't appreciate, experts note. They are a good spot for your money if you are preparing to make a down payment on a house, or waiting to pay taxes, for example. A salary bonus or an inheritance could also go into a money fund until you decide how to use the money.

"Investments in money funds are temporary," says Gerald Perritt, editor of The Money Fund Letter, in Largo, Fla. "But if you have a balance in your money fund that never goes down below $10,000, just to pick a number, then what you've done is permanently invested $10,000 in money funds." The downside of that, he says, is that after taxes and inflation, your return on that money will "melt away" while it sits there.

Yield. Money funds in the recent past have offered better rates of return than CDs or money-market deposit accounts (MMDAs) from banks. The average yield for taxable money-market funds for the week of March 11 is 4.73 percent, IBC/Donoghue reports.

That is higher than the annual percentage yield on MMDAs at 2.74 percent, but has fallen closer to six-month and one-year CD yields, which are at 4.54 and 4.67 percent, respectively for the week of March 11, according to Bank Rate Monitor, a North Palm Beach, Fla., newsletter.

Money funds for individual investors come in both taxable and tax-free varieties. Investors in higher tax brackets may get better after-tax yields with tax-free funds, some financial advisers say.

The increase in the number of money-market funds in the last two years has strengthened competition for investor dollars, notes Tracy Burk, editor of money-market publications at IBC/Donoghue. As a result, more funds are waiving all or a portion of their expenses in order to make yields look better, she says.

Remember to ask if a fund is waiving its fees. If it is, find out for how long and what the yield will look like after that time.

The ideal fund, Ms. Burk says, is one that is not waiving but is "still a top yielder."

Liquidity. Money funds are considered a cash-like investment. You are able to get to your money quickly if you need it. Money funds are "a lot more liquid" than bank products, says Jay Mueller, who manages several money-market funds for Strong Capital Management Inc. in Milwaukee.

Unlike bank CDs, which will often have prepayment penalties, with money funds, theoretically, "you can put your money in today, [and] take it out tomorrow if you want," he says.

Services/ease of use. You should check with the fund company on what services come with the money-market fund.

These often include check-writing privileges (usually for larger amounts, such as $250 or more, for example), a money-wiring service, and the ability to move the money easily in and out of other mutual funds offered by the same company.

These days, companies that offer money-market funds tend to offer similar services, says Porter Morgan, senior vice president and investment strategist at Liberty Financial Associates, a mutual-fund company in Boston.

He sees two major reasons to go with the money-market fund within the fund family you are already invested in: (1) You can move your money with a simple phone call, and (2) among the money funds offered by various companies "the yield differentials do not tend to be real large."