QUESTION: I want to open a money-market mutual fund while I save for a down payment on a house, but I don't know where to research these funds or how to purchase one without the services of a broker.
But while these returns may seem mediocre at best (consider that at the end of last year the average yield was around 6%), a money-market fund is still a great way to save for a short-term goal or simply to house an emergency stash. It can also serve a convenient resting place to park cash while you decide where to invest it long-term, points out Dee Lee, a certified financial planner in Harvard, Mass. That's because, unlike a certificate of deposit, a money-market fund doesn't tie up your money for a fixed amount of time. (Although, in this environment, a CD will offer you somewhat higher returns.) And as paltry as 3.6% returns may seem, they're certainly better than the 2.5% national average you'd get from a bank, according to Banx.com.
Pretty much every fund family and brokerage firm offers a money-market fund. To narrow the field, the easiest place to begin a search is at iMoneyNet.com, which ranks money-market funds based on their seven-day yields. Keep in mind, if you have a brokerage or mutual-fund account already, it might be convenient for you to stick with that company. "You want to make your finances less complicated," Lee says. "It's nice to have your personal investments in one place."
As you begin your research, one of the first questions you should ask yourself is whether you want a taxable or tax-free fund. The yields on the tax-free funds are somewhat lower than those on taxable funds, but if you're above the 28% tax bracket, then that could still be the way to go. Likewise, if you live in a state with high taxes, you might want to go with a fund that offers a break on state tax as well as a federal one. To find out if a tax-free yield is better than a taxable one in your case, divide the tax-exempt yield by the difference between one and your federal tax bracket. So if you're in the 31% tax bracket, the tax-equivalent yield on a tax-free money-market fund yielding 3.0% would be 3.0/(1-0.31), or 4.34%.
The other thing you need to consider is fees, warns Peter Crane, vice president and managing editor of iMoneyNet's Money Fund Report. Fees always matter when you're judging a fund, but money-market funds' lower yields makes penny-pinching even more important. "If yield is your primary consideration, then fees are also your main concern," Crane says, adding that his firm estimates that 90% of the difference in money-market-fund returns is attributed to the expense ratio.
Once you've identified the appropriate fund, there's absolutely no need to pay a broker a commission to purchase it. After scrutinizing the prospectus and semiannual report, you can simply call the fund company's toll-free number and request an application through the mail, or in some cases, take a trip online and download the form yourself.
One final note: A money-market fund will make sense for you provided you're pretty close to starting your house hunt. If you're just beginning to set aside funds for that down payment, however, and your new home is a couple of years away, you might want to be a bit more aggressive. We realize that can be pretty scary advice in this market, but if you seek a little more yield, a short-term bond fund might do the trick. These generally offer a slightly higher yield since the durations of the holdings are a bit longer than you'd find in a money-market fund.