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Money-Market Funds Explained
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MONEY-MARKET FUNDS are often touted as the safest kind of mutual fund, but that depends on your
perspective. On the one hand, it's almost impossible to lose your principal in one of these things. On the
other, their returns are so low -- 4% to 6% on average -- that they can't beat inflation over time. In the
long term, your money loses its buying power and so actually becomes less valuable. Consequently,
money-market funds are most useful for parking cash you need in the short term -- a car or house
down payment, for instance, or next year's tuition.
The reason money funds are so stable is because they invest in ultra short-term securities like those
issued by banks, the federal government or big companies with Grade A credit ratings. Your return
comes in the form of a dividend. In these respects, money-market funds are very similar to a bank
certificate of deposit. The advantage of a money fund is that it is completely liquid. Unlike a CD, which
will lock up your money for at least six months, you can sell your shares in a money fund at any time.
They also often offer perks like the ability to write checks against the principal. The advantage of a CD
is that your deposit is usually insured by the federal government.
There are various types of money-market funds based on the type of securities they buy, but the most
important distinction is whether your dividends are taxable or tax-free.
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