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Stocks may not have registered a 20% gain in 1999, but one type of investment is enjoying a boom year: money market mutual funds. “Assets increased by 20% from late 1998 to late 1999,” says Peter G. Crane, managing editor of IBC’s Money Fund Report, which is published in Ashland, Massachusetts. With a total of $1.5 trillion, money fund assets now top those held in bond mutual funds and bank checking accounts. Crane expects the total to exceed bank savings accounts within a year.
Why the rush into money funds? “People are unhappy with the rates they’re getting in day-to-day bank accounts,” Crane says. “They don’t want to stretch for yields with two-year bank CDs because they’ll lose out if yields go up during that period.” Anxieties over a volatile stock market and Y2K computer problems add to the lure of money funds.
Money funds offer competitive yields (the national average for taxable money funds is just under 5% now), penalty-free access to your money and safety. Only one small money fund has ever stuck investors with a loss of principal, back in 1994, and investors still wound up with 96 cents on the dollar.
The catch? Even at 5%, money fund returns aren’t fabulous. Over the long haul you’re likely to reap higher returns from stocks and bonds. Thus, money funds make the most sense as a source of emergency cash.
“Virtually everyone should have at least $4,000 or $5,000 in a money fund,” says David Foster, a CPA and fee-only certified financial planner in Cincinnati. “Some people will need more, depending on their circumstances.”
Foster says that for the cautious investor, money market funds can also help minimize risk. “Spreading out your investments over a specific time period will reduce the risk of committing a large amount at just the wrong time, such as before a market correction,” he says.
Don’t choose a money fund simply because it has the highest yield: going from 4.8% to 5.3%, for example, will give you an extra 50 basis points, or $25 per year on a $5,000 holding, just enough to fill your car with gas twice.
Foster notes you should choose a money market mutual fund based on where you already do your investing or banking. If you select a money fund through your bank (which offers lower yields than investment firms), you may be able to win lower fees on your other accounts, he adds.
You also must decide whether to put cash into a regular taxable money fund or into a tax-exempt fund. IBC’s Crane notes that at current rates, it may not be advantageous for most people to choose tax-free money funds. For example, if you’re in a 31% federal tax bracket and you earn the average 4.8% from a taxable money fund, you’d net 3.3% after-tax, more than the 3.1% average yield on a tax-free money fund.
“Tax-free funds may help if you’re in the highest tax brackets and live in a high-tax state like California or New York,” says Crane. “Moreover, there are
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