Introduction to Money Market Mutual Funds

BY Jason Van Bergen

Since money market instruments such as Treasury bills (T-bills) and certificates of deposit (CDs) require initial investments that only the wealthiest of investors can undertake, individual retail investors interested in the money market are limited to money market mutual funds, which don't require initial outlays of tens (or even hundreds) of thousands of dollars. That said, even smaller investors who purchase money market mutual funds are advised to have at least a rudimentary understanding of such instruments as T-bills, CDs, and municipal notes ("munis"), as these are the products that will form the bulk of their money market mutual fund purchases.

Purpose of Money Market Mutual Funds for Investors
There are three instances when money market mutual funds, because of their liquidity, are particularly suitable investments. First, money market mutual funds offer a convenient parking place for cash reserves when an investor is not quite ready to purchase an individual stock, bond or mutual fund for his or her long-term portfolio holdings. Money market mutual funds offer ultimate safety and liquidity. This means that investor will have an expected sum of cash at the very moment that they need it.

Secondly, an investor holding a basket of mutual funds from a single fund company may occasionally want to transfer assets from one fund to another. If, however, the investor wants to sell a fund before deciding on another fund to purchase, a money market mutual fund offered by the same fund company may be a good place to park the proceeds of sale. Then, at the appropriate time, the investor may exchange his or her money market mutual fund holdings for shares of the other funds in the fund family.

Thirdly, to benefit their clients, brokerage firms regularly use money market mutual funds to provide cash management services. Putting a client's dormant cash into money market mutual funds will earn the client an extra percentage point (or two) in annual returns above those earned by other possible investments.

Operational Details of Money Market Mutual Funds
Money market mutual funds are designed to offer features that are particularly suited to the needs of small investors. Minimum initial investments range from $500 to $5,000, whereas the minimum initial investments of other money market instruments range from $5,000 to $100,000, or even higher.

You can purchase money market mutual funds directly from brokerage companies or mutual fund firms, just as you would purchase a stock or equity mutual. Also, many banks offer sales of money market funds and even act as investment advisors to clients interested in purchasing funds. Some banks have their own proprietary money market funds, as securities legislation now gives banks the right to advise customers to invest in the banks' proprietary funds.

Money market mutual funds also offer some simplified withdrawal features that are more typically associated with bank or trust accounts. For example, money market funds allow investors to withdraw assets by writing checks, usually of a minimum amount, say, $500 per check. If the investor does not want to write a check as a means of withdrawing funds, he or she can easily redeem shares by requesting payment by mail or by remittance through a wire transfer to his or her bank account.

Categories of Money Market Mutual Funds
Money market mutual funds may contain a specific type of money market security or a combination of securities across a wide spectrum. That said, most funds adopt a specific investment philosophy that relates to a particular money market instrument.

One particular type of fund limits its asset purchases to U.S. Treasury securities. Another class of money market funds purchases both U.S. government securities and investments in various government-sponsored enterprises. The third and largest class of money market mutual funds invests solely in privately issued money market securities that offer the highest degree of security, such as those rated "A1" by Standard %26 Poor's or "P1" by Moody's.

ADVERTISEMENT
Get a FREE Learning Kit on Managed Futures and Portfolio Diversification
In 18 months investors have put more money in managed futures than in 22 years! The Kit includes audio and video tapes and a beautiful color brochure. Video filmed at HBO studios. Valued at $95, it's yours free while supplies last! Click Here to get yours mailed today

A second important categorization for money market mutual funds relates to their taxable or tax-exempt status. Taxable funds invest in securities such as Treasury bills and commercial paper, whose interest income is subject to federal taxation. Tax-exempt funds invest exclusively in securities that are issued by state and local governments and are exempt from federal taxation. Tax-exempt funds generally appeal to those investors in a higher federal tax bracket who are seeking tax savings on the overall interest income generated by their portfolios.

Some tax-exempt funds purchase only securities issued by governments within a particular state. If an investor can find such a fund for his or her home state, that investor can earn interest income that is exempt from federal, state and perhaps even local income taxes. Tax-exempt money market mutual funds have the potential to offer a triple-whammy tax reprieve for investors!

Conclusion
Just as equity mutual funds have greatly simplified the world of equity investing, money market mutual funds have made money market investing accessible to individual retail investors. Money market mutual funds are among the safest and most liquid financial instruments widely available. Moreover, money market funds offer modest initial investment requirements and provide simple procedures for withdrawing funds by check or transfer to a bank account. Finally, if they choose carefully, purchasers of certain tax-exempt money market funds may also enjoy relief from federal, state and even local taxation.

Jason Van Bergen

1investmenthelp.com Copyright © 2007, All Rights Reserved