money market fund
A mutual fund that sells shares of ownership and uses the proceeds to purchase short-term, high-quality securities such as Treasury bills, negotiable certificates of deposit, and commercial paper. Income earned by shareholders is received in the form of additional shares of stock in the fund (usually priced at $1 each). Although no fees are generally charged to purchase or redeem shares in a money market fund, an annual management charge is levied by the fund's advisers. This investment pays a return that varies with short-term interest rates. It is relatively liquid and safe but varies in yields and features. Both taxable and tax-exempt varieties of money market funds are offered. Also called liquid asset fund
. See also average maturity
Case Study Choosing between a taxable and tax-exempt money market fund is a function of an investor's marginal tax rate and the difference in yields between the two types of funds. A higher marginal tax rate makes it more likely an investor will earn a higher aftertax return from owning a tax-exempt fund as opposed to a taxable fund. Likewise, the smaller the difference in yields between the two funds, the more likely an investor will benefit from choosing a tax-exempt money market fund. In late November 2001 the largest taxable money market fund managed by Smith Barney paid an average seven-day annualized yield of 1.88%. At the same time the firm's main tax-exempt fund offered a yield of 1.36%. An investor in the 35% federal tax bracket who owned the taxable fund earned an aftertax return of 1.88 × (1 - .35), or 1.22%. This investor paid the Internal Revenue Service 35% of the 1.88 taxable yield, leaving a return of only 1.22% after taxes. Thus, an investor in the 35% tax bracket would have been better off owning the tax-exempt money market fund that paid an aftertax yield of 1.31%. On the other hand, an investor who faced a marginal tax rate of 27% earned an aftertax return of 1.88 × (1 - .27), or 1.37%, by owning the taxable money fund, somewhat better than the return provided by the firm's tax-exempt fund. The yield difference between taxable and tax-exempt funds is constantly changing, so it is important for an investor to remain alert and consider transferring money from one type of fund to the other as yields warrant.
Money market fund.
Money market mutual funds invest in stable, short-term debt securities, such as commercial paper, Treasury bills, and certificates of deposit (CDs), and other short-term instruments.
The fund's management tries to maintain the value of each share in the fund at $1.
Unlike bank money market accounts, money market mutual funds are not insured by the Federal Deposit Insurance Corporation (FDIC).
However, since they're considered securities at most brokerage firms, they may be insured by the Securities Investor Protection Corporation (SIPC) against the bankruptcy of the firm. In addition, some funds offer private insurance comparable to FDIC coverage.
Tax-free money market funds invest in short-term municipal bonds and other tax-exempt short-term debt. No federal income tax is due on income distributions from these funds, and in some cases no state income tax.
While taxable funds may offer a slightly higher yield than tax-free funds, you pay income tax on all earnings distributions.
Many money market funds offer check-writing privileges, which do not trigger capital gains or losses, as writing a check against the value of a stock or bond fund would.