About the Best Money Market Rates
Money market mutual funds represent a multibillion-dollar investment segment. They are a primary source of liquidity for corporations, pension funds and individuals. Money market funds are liquid and safe, which adds to their appeal. However, there are many variations that can prove difficult to understand without research.
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Background
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Money market funds are regulated under the Investment Company Act of 1940. Money market funds are managed by mutual fund companies, which charge a management fee to create and run a portfolio of securities just like any other mutual fund. However, money market funds specifically are cash equivalents and purchase only short-term, safe securities. These range from commercial paper, treasury and agency debt and repurchase agreements. They are required to be relatively short in duration to provide daily liquidity.
Types
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There are five types of money market funds to consider:
1. Prime. Prime investments are in corporate commercial paper, repurchase agreements, treasuries or any other short-term, fixed-income types of investment.
2. Government. Government investments are solely in treasuries or government agency securities (the Government National Mortgage Association, for example) and repurchase agreements.
3. Treasury. Treasury funds come in two types--those that invest 100 percent in U.S. Treasuries and those that invest in U.S. Treasuries and repurchase agreements.
4. Tax-free. Tax-free invests in municipal securities or other instruments not subject to taxation. Be aware that some of these funds avoid securities subject to the Alternative Minimum Tax (AMT) and some do not.
5. Off-shore. These funds are typically U.S. dollar-denominated but invest in short-term, fixed-income investments overseas. -
Comparison
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Mutual funds are baskets of stocks or bonds that have varying prices each day. A net asset value (NAV) is the overall price of the fund, which is calculated at the market close each day to reflect the changes in the underlying holdings of the fund. Although money market funds, by definition, keep a constant NAV of $1, the yield, or interest, the fund pays varies widely by market segment as well as by fund company. Prime funds will almost always offer the highest yield but also carry more risk, simply because they invest in private corporations that may go out of business. The next highest yield comes from government funds because government agency debt carries more risk than that of the federal government. Last is Treasury funds because Treasury debt is guaranteed by the federal government.
Choosing the type of fund is the most important decision. Secondary is the particular fund company. There are yield differences because managers can get lucky or have better information. Sticking with well-known names, such as Fidelity, Vanguard, Goldman Sachs and the like, is generally the least risky way to invest in money market funds.
Rates
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Since money market funds invest in short-term liquid investments that change yields on a daily basis, the funds' yield changes on a daily basis. Money market funds are not investments in which you invest funds and forget about it; you need to monitor rates closely to capture additional yield by moving funds (assuming transaction costs to do so are not prohibitive). The best rates are offered to institutional investors with large amounts to invest. Today these funds are yielding about 45 basis points; however, most investors can hope to get 20 to 30 or less. Fidelity, the largest fund company in the United States, offers the Fidelity Institutional Money Market with a 48-basis point yield as of Sept. 11, 2009, and a Fidelity Cash Reserves fund at 30 basis points. This is not to be confused with Money Market accounts in which a bank may pay a higher rate (as of today) to attract your deposit; however, when interest rates eventually rise, money market accounts will not go up much, whereas money market funds will move in lock step.
Considerations
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Money market funds and money market accounts play an important role in managing finances and providing liquidity to investment markets. Money market funds are an ultra-safe, highly liquid vehicle for cash to move around the economy, and money market accounts are an important vehicle for funneling money into these investments.
Look closely at the instruments in which a money market fund invests; these are typically posted on the website of the fund company. Also, examine in detail any fees charged. Paying for a better yielding investment is only worthwhile if the yield is greater than the fee. Lastly, if you invest in a money market account, and only one money market fund is offered, ask if other options are available, especially if you have a high balance.
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