All about tax free money market fund

Tax free money market fund is a great way to balance your investment portfolio especially in these troubled economic times. These money market funds are also called as tax exempt money market funds. A money market fund is a mutual fund that invests only in cash or cash equivalent securities, which are also referred to as money market instruments. These investments are short-term, very liquid investments with high credit quality.

The money market instruments include:

• Certificates of deposit (CDs)
• U.S. Treasuries
• Commercial paper
• Repurchase agreements
• Bankers' acceptances

As per the Securities and Exchange Commission (SEC) rules, the average maturity of money market fund securities should be 90 days. Like any other normal mutual fund, money market funds also have redeemable units and they need to follow the same guidelines as given by SEC. There are various special features of these money market funds like security, low initial investment and liquidity which make these types of funds popular in investors. Since the funds invest the money in securities which are safe and stable investments, these funds are considered to be a very safe option even in a volatile market and still providing a reasonable return on investment.

Also, the minimum investment in these type of funds is pretty low which is another reason investors find them popular. As such, money market funds allow you to take advantage of the safety related to a money market investment at low investment amounts.

And another special feature is the liquidity or accessibility of your funds. Shares of money market can be bought and sold anytime irrespective of market timing window which is a huge advantage. Most of these funds available today come with check writing privileges as well. And these funds offer same day settlement instead of T + 3 settlement period. Al these factors make money market mutual funds a good and popular choice for the investors to balance their portfolio.

These money market funds come in two variations – taxed and tax free money market funds. As the names suggest, any returns from a taxable fund are subjected to taxes both state and federal taxes as applicable. On the other hand tax free money market fund is totally tax free in investor's hands. But the tax free money market funds don't provide many options to the investors. These funds often invest in short term federally tax exempt entities called municipal securities. And these types of funds have generally lower yield than taxable funds.

While buying a taxable or tax free money market fund, you need to check the yields on both of them. Juts the yield number is not enough to make the distinction. You should also check whether the tax savings attached to the tax free fund makes it worth while to buy this fund instead of taxable fund. While doing this comparison, you should convert the tax free yield into equivalent taxable yield. The formula for this conversion is given below:

Taxable Equivalent Yield = Tax-Free Yield / (1 – Marginal Tax Rate)

Before deciding to buy a taxable of a tax free money market fund, you should check a few things which are common to any type of investment like expense ratio (lower the better), investment objective of the fund (should match with your investment objective) and risk factors (should match with your risk appetite). These factors are important to understand so that you are sure that you are investing in the right financial avenue as per your need and risk appetite.

There are various good tax free money market funds available in market today including Vanguard Tax-Exempt MMF (VMSXX), American Century Tax-Free MMF (BNTXX), T. Rowe Price Tax-Exempt Money (PTEXX), Fidelity AMT Tax-Free Money Fund (FIMXX). All these funds have different effective yield, minimum investment and expense ratios so it is important to compare them properly before finalizing the one for you. In short, a tax free money market fund is a great place to place your money for short term while you wait for the right securities to buy.

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