Tips in Choosing Money Fund
November 29, 2008 – 3:20 pmIf you're new here, you may want to learn what this site is about. Please subscribe to my RSS feed to get latest updates on this blog. Thanks for visiting!
When choosing a money fund, do your best to avoid any that own complex derivatives. It’s up to you to watch out for potential land minus. One red flag: If your money-market fund is yielding a quarter of one percentage point more than its competitors holding similar investments and its expenses are about average, there’s a pretty good chance the manager owns some derivatives to boost his yield. To better assess the potential risks in a money fund, call its toll-free 800-number and get answers to these two questions:
1.What percentage of the fund’s assets are exposed to structured notes, floaters, strips, and other exotic derivatives? If a money-market fund has more than 5% of its assets in these derivatives, you should be skeptical.
2.Why is the fund using derivatives, and can it archive the same goals through simpler means? Some funds –including many of the money-market funds that ran into trouble –have used derivatives to circumvent restrictions limiting the maturity if the securities they own. If the fund you’re considering is doing this, you may want to find another one. At the very least, you should ask the money fund telephone sales rep what could go wrong with its strategy.
The ultra-safety conscious might want to put short-term savings in a U.S. government money fund. Government money funds are composed solely of T-bills or other government obligations that mature within a year and can be easily identified from their names, which usually include the word “government”. Government money funds that invest strictly in U.S. Treasuries are exempt from state and local income taxes, like all direct obligations of Uncle Sam. They are, however, still subject to federal income tax.
If you’re in a high income tax bracket, you might want to consider keeping your short=-term savings in a tax-free money-market fund. These funds buy short-term free from federal income taxes. To figure out if tax-frees are right for you, check the list of the month’s top performing taxable and their toll-free phone numbers in the “Monitor” column of a recent issue of MONEY. Subtract your income tax bracket from 100 and divide the remainder into the tax-free yield you are considering. For example, suppose the average tax-free money fund yield is 3.5% and you are in the 31% bracket. You would have to fund a taxable money fund yielding at least 5% to earn more than the tax-free fund (100 minus 31 equals 69; the divided into 3.5 equals 5). If you live in a high-tax state, you can increase your after-tax yield even more by choosing a money-market fund that sticks to tax-free securities issued in your state.
If you like this post, please subscribe to my RSS feed to get latest updates on this blog. Thanks for visiting!
| 3.3 |
1 Trackback(s)