Most Popular Tax-Free Money Market Funds

Nov 15, 2023 By Triston Martin

A money market is a form of mutual fund that invest solely in short-term debt-based assets with a good credit rating and a short maturity, such as cash and cash equivalents. Therefore, these products provide excellent liquidity with minimal exposure to risk.

The primary goal of a money market fund is to generate income while keeping each share's NAV at $1 at all times. Reference interest rates for the money market, such as LIBOR, are the basis for money market fund benchmarks.

Some money market funds also provide tax-free returns to clients who meet specific requirements, so they're not only low-risk investments. For comparison, these funds will generally utilize the average performance of a group of tax-free money market funds.

Fidelity SAI Municipal Money Market

Money market fund FMQXX aims to maximize tax-free interest income without compromising principle stability or liquidity. At least 80% of the fund's assets are placed in municipal securities with interest-free from federal income tax.

Financial Mutual QXXI may invest up to 20% of assets in securities subject to state and federal income tax. As of the 29th day of February 2020, the fund is made up of the following instruments: 85.0% Variable Rate Demand Notes (VRDN), 4.4% Commercial Paper, and 3.5% Municipal Notes.

Vanguard Municipal Money Market

As a money market fund, VMSXX aims to give its shareholders a federally tax-free investment return while conserving their capital. The fund's assets comprise various high-quality municipal securities with short maturities. As of February 29, 2020, 100% of the fund's assets will be invested in tax-free securities.

Invesco Treasurer's Ser Tr Prem

Money market fund PEIXX aims to minimize tax liability without sacrificing liquidity or capital preservation. The fund's holdings consist primarily of tax-exempt business paper, revenue bonds, & general obligation notes, all of which are high-quality, short-term municipal liabilities. As of February 29, 2020, the fund's holdings are made up of 82.9% VRDNs, 11.7 % Other Municipal Security, and 5.4 % U.S. Government Agency Repurchase Agreement. 5

Benefits of investing in money market funds

Low to Moderate Danger

Since money market funds invest in short-term securities with maturities of up to a year, they are subject to little interest rate risk. These funds also have a low credit risk because they solely invest in money market assets. Therefore, money market funds often yield low-volatility returns.

Easy market access

Money market products are not available to retail investors. Investing in money market assets is made easy by money market funds. Money market funds can hold assets with maturities of up to 1 year, whereas liquid funds can only invest in money market securities with maturities of up to 91 days.

So, money market fund shareholders have access to a more diverse set of money market instruments across a more extensive range of maturities, increasing the profits that the fund may generate. Also, there is often no lock-in period or exit fees associated with these funds, so they are pretty liquid.

Consistent Profits

Because money market fund values don't fluctuate considerably in reaction to changes in market rates, investors may count on consistent returns from their investments even throughout periods of interest rate tightening and relaxation.

The funds primarily profit from increased interest income, which grows when market rates rise. If there is a drop in market rates, they can offset the loss of interest income with gains in the stock market.

Advice for Potential Money Market Fund Investors

Investing in money market funds raises two significant safety and security issues. While these funds often put their money into low-default, short-term assets, it doesn't imply they are entirely safe from credit risk.

When the issuing firm failed to meet its interest obligations, the rating of formerly highly rated commercial paper was recently reduced drastically. If a money market fund's holdings include downgraded or defaulting debt paper, the fund's value is likely to decline significantly.

Taxes on Money Market Investments

Dividend income and capital gains are available to investors in money market funds. Dividend taxes will be levied according to each investor's tax bracket beginning with the 2020-21 fiscal year. Capital gains may be classified as short-term or long-term depending on how long an investor has held the fund.

Short-Term Gains

Any profits made on the sale or redemption of an investment by a shareholder who has held it for less than three years would be deemed short-term capital gains and taxed at the shareholder's marginal income tax rate.

Long-Term Capital Gains

The benefit of "indexation" is enjoyed by investors who hold a money market fund for more than three years before redeeming or selling their shares. The purchase price is adjusted before the profit is determined to account for inflation. The current tax rate on long-term capital gains is 20%.

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