Best Mutual Funds Explained
All you need to know about mutual funds, including the risks, rewards and terms  

Money Market Mutual Funds

best mutual fundsThe final group of fund types in our search for the best mutual funds is money market funds. As we saw earlier the principle difference between a money market fund and a bond, is time. Money market funds are defined as short term loans, with the maximum being 397 days or 13 months. The terms of the loans are strictly controlled in order to manage risk, with strict rules governing the use of the money by the borrower. Money market funds are often described as the safest type of all mutual funds, and whilst it is almost impossible to lose your original capital, your returns will probably suffer from the effects of inflation as we shall see when we look at the risks and rewards of mutual fund investing.

In broad terms there are really only two types of money market funds, namely taxable and tax exempt, so a little more straightforward than the other funds we have look at so far! Let's look at each group starting with the tax exempt money market fund.

Best Mutual Fund - Tax Free Money Market Fund

Tax free or tax exempt money market funds are those that invest in loan securities issued by the state or local government and on which the interest earned is free from federal income tax. The first of these was issued in 1977, but really only became popular during the mid 1980's and early 1990's. In recent years, there has been an enormous growth in locally issued securities within a state, which offer the threefold benefit of being free of federal, state, and in some cases local taxes as well ( though not always, so you will need to read the small print carefully) - so truly tax free in the broadest sense. These are often referred to as double-tax free, or triple-tax -free. These types of money market mutual funds have proved particularly popular in areas of both high taxes and high populations such as California and New York.

All money market funds are tightly regulated by the Securities and Exchange Commission under the Investment Company Act of 1940. The SEC regulates the length of time to maturity ( generally 13 months maximum ), the maximum percentage of the fund which may be invested in one issuing body ( 5%) and various rules for rating of the loan debt according to credit scores for the issuer. The key component for all money market funds is that they must be highly liquid and therefore easily convertible back to cash. This applies to both tax exempt and taxable money market mutual bonds. Under SEC rules, the average maturity of all money market funds, whether tax free or otherwise must be around 90 days in order to fulfil this criteria.

When comparing tax free returns against taxable money market returns the initial result can be misleading, as on paper you will generally see that a tax free mutual fund will often return less, however, you must remember that you do keep more of the income due to the tax free rating, so we have to look at something called comparative yield or taxable equivalent yield. We'll look at this in more detail when explaining some of the terms and risk and rewards associated with all the various types of mutual funds, and how to pick the best ones. As a general rule, taxable money market funds are generally better for regular investors, whilst tax free funds will tend to be the best, the higher the rate of tax you pay.

Best Mutual Fund - Taxable Money Market Fund

Taxable money market funds work in much the same way as the above, except that of course they are taxable. Typically they invest in Treasury bills and Commercial paper, and you will have to pay federal tax on any income. These two groupings are often listed separately as either General Funds which invest in commercial or bank issued loans, and Government Funds which invest in US Treasuries. In addition we also have GNMA ( Government National Mortgage Association ) and FNMA, ( Federal National Mortgage Association )  loans, often abbreviated to Ginnie Mae and Freddie Mac. Both of these are chartered by Congress( and therefore very safe ) and have been established to buy mortgages from lenders, and then to repackage them to sell on as securities. This provides a continuous flow of money to the banks and lending institutions who are then able to issue further mortgages to borrowers. This practice has been a contributory factor to the recent sub prime mortgage crisis which has engulfed world economies over recent years, and is still continuing today.  

One of the interesting characteristics of money market funds is that with most funds you do have the ability to write cheques against the funds, generally around a minimum of $500. However please remember that there is one significant difference between a regular checking account with a retail bank, and the same facility with a money market fund - your deposits in a bank are secure and guaranteed, whereas in a fund they are not, so please always remember this fact when considering investing in money market mutual funds.

Now, having looked at money market funds, let's take a look at some of the odd terms you will come across when you research the market looking for the best mutual funds.

Best Mutual Funds - next page