High Yield Money Market Mutual Funds

One savings alternative that you can use to store your cash is a money market mutual fund. Available from brokers and investment companies, these highly liquid investments can boost your yield beyond those of local banks.

A money market fund usually buys very short term bonds, known in the investment world as commercial paper. Large corporations use this commercial paper to help fund day-to-day activities – sort of a large-scale petty cash account. The money market funds carry a little more risk because they are not FDIC insured, but no large, reputable company has ever “broken the buck,” or allowed the fund share price to drop below its constant value of $1.00 per share.

One of the highest yielding money market funds out there today is the Fidelity Cash Reserves fund, ticker symbol FDRXX. Joe SuperSaver owns this fund in his Fidelity retirement brokerage account, using it to hold uninvested cash and to collect dividends and capital gain distributions from stocks and mutual funds.

Fidelity’s current yield (as of August 2, 2008) was 2.43%, with an average maturity of 52 days. The yield is based on an average of the past seven days, while the average maturity is the average remaining active life of all the short term bonds in the portfolio. A clever fund manager will extend the maturity when interest rates are expected to go down (thereby locking in the current yield), and will shorten maturity when interest rates are expected to go up (allowing the manager to buy new bonds at higher coupon yields.

The yield tends to track short-term rates. Ben Bernanke and the Federal Reserve meet eight times per year to set a Federal Funds rate, which has a strong influence on short-term rates, and hence money market rates. The Fed has held steady at 2% for a while now, so money market rates have also stabilized. You’re getting a good deal in money market rates anytime the yield is higher than the Fed rate.

A good alternative to Fidelity’s offering is the Vanguard Prime fund, ticker symbol VMMXX, especially if you already own other funds in Vanguard’s extensive line of investment choices. Joe SuperSaver has owned the VMMXX fund for several decades (remember how old he is), and the fund is usually at or near the top of the yield list because of Vanguard’s well-known penchant for penny-pinching. Current yield is 2.21%.

A final choice is Paypal’s money market fund, ticker symbol PAPXX. Joe SuperSaver, like many others, owns this fund as part of the normal act of transacting on-line business with eBay and other retailers. Unknown to many, the fund has an exceptionally high yield (current 2.32%), with easy on-line transfers into and out of the fund through a linked checking account.

Both Fidelity and Vanguard have checking privileges as options when an account is set up. Note that the respective minimums on these checks are $500 and $250.

Can you do better with your short-term savings than with money market funds? Yes, several on-line banks are now offering savings rates as high as 3.5%. On-line banks may use this same commercial paper as the base for their investments, or may fund the accounts from other bank activity. Depending on the source of the funding, bank on-line rates may be higher or lower than the money market mutual funds previously described. The bank rates tend to react a little more slowly to changes in interest rates, which could be a disadvantage when short-term rates go up. On the other hand, most on-line bank deposits are FDIC insured for the full $100,000 per account.

When deciding where to stash your cash, think in terms of the rest of your portfolio. If you are tied into one or more mutual fund families with other investments, the money market funds offer a convenient way to switch into and out of cash and to store dividend payments if they are not reinvested with the fund. If you’re just looking for a safe place to keep money and want a higher yield, the on-line bank choice would be a good bet.

For more information:

See Fidelity’s web site at fidelity.com
See Vanguard’s web site at vanguard.com
See PayPal’s web site at paypal.com

Check out the current yield of any of these funds at finance.yahoo.com, typing in the 5 letter ticker symbol in the quote box.

Smart Money just published an article on the Best Money-Market Funds, and features the Fidelity Cash Reserves fund. Read about it at smartmoney.com

See bankrate.com for a daily update of the highest yielding on-line bank accounts. This web site also publishes tracking information on CD yields, mortgage rates, car loan rates, and a host of other money-related statistics.