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Considering Tax-Exempt Money Market Funds

This article was written by in Investing. 14 comments.

A few days ago, I mentioned I invested in the stock market at a low with money marked for an intermediate time horizon. I didn’t get the price I wanted, however. I initiated the $3,000 investment in VTSMX, the index fund following the total stock market, on Monday night following the stock market’s sharp decline. My order at Vanguard wasn’t placed until Tuesday’s fund price was set, after the market had regained over half of its losses.

Next time, I will be prepared to take advantage of dips at the right time. As commenters suggested, I will opt for an ETF that tracks the market, accepting a small transaction fee in return for an immediate price. Additionally, I’ll keep money in a money market account at a brokerage to eliminate a delay caused by transferring funds from an external account.

Additionally, I believe it’s time to get a better rate of interest for the cash in savings I might need within a year. This short-term money would earn a better return in a money market fund. The bulk of my cash is earning 3.0% APY at ING Direct and some earning more at FNBO Direct. Yesterday, however, I invested a big portion of my cash in VNJXX, the New Jersey Tax-Exempt Money Market Fund.

This money market fund is currently earning 4.83% APY based on the average yield over the past seven days, and the interest income is tax-free, both federal and state (for me as a resident of New Jersey). Since there are no fees, as the economic situation changes and the fund begins earning less than the after-tax equivalent of a high-yield savings account, I can easily move the funds back.

Money Market Funds like VNJXX are riskier than savings accounts, however. The prospectus outlines five specific risks: state-specific risk, income risk, credit risk, manager risk, and non-diversification risk. I weighed these risks and determined that the fund is a better option for most of the cash I am keeping for short term goals like purchasing a house.

Updated August 16, 2013 and originally published October 2, 2008.

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About the author

Luke Landes is the founder of Consumerism Commentary. He has been blogging and writing for the internet since 1995 and has been building online communities since 1991. Find out more about Luke Landes and follow him on Twitter. View all articles by .

{ 14 comments… read them below or add one }

avatar 1 Anonymous

These yields are amazing espically if you are in the 25% tax bracket and above. I just moved my cash sitting on the sidelines to the Vanguard tax exempt money market fund. 7.5% equivalent yield with a low 0.17% management fee. Can’t beat that in today’s market.

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avatar 2 Anonymous

Wow, I wonder if there is any similar investment option available for residents of Washington State.

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avatar 3 Luke Landes

Josh: Since Washington does not have an income tax, you’re already a little better off even with taxable savings. You could invest in Vanguard’s Tax-Exempt Money Market (VMSXX), which is exempt from federal income tax only. As of today this fund’s 7-day yield is 5.83%.

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avatar 4 Anonymous

This NY Times article ( outlining the crisis mentions money market funds. There was apparently a big run on money market funds. Do you think they are still safe? I don’t have enough expertise to tell you whether or not they are, but thought it was good food for thought.

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avatar 5 Luke Landes

The problem with some money market funds recently was their underlying investments. Rather than corporate bonds, the investments behind the money market funds that “broke the buck,” VNJXX invests in municipal securities, and only those that are highly-rated. So there is risk, but it’s a bit different than the money market funds cited in the news recently. The risk is prrimarily based on the state’s financial condition — which is never *good* as far as I can tell, but it should be relatively stable.

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avatar 6 Anonymous

Just for everyone’s info, when you make a non-recurring electronic purchase into a Vanguard mutual fund, any trade entered prior to 10 pm receives the next day’s trade date (and price).

I happened to get lucky twice in a row now – my automatic investment gets a trade date of every other Monday, so my last two purchases have both gone in after enormous drops that were mostly recovered the next day :-)

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avatar 7 Anonymous

Those yields are tantalizing, but as you know, your money is not guaranteed under the FDIC. This makes me a bit nervous right about now and I might be inclined to stick to my 2.65% money market account.

I thought that the government guarantee might make it a no brainer, but as you can see, you would have had to put your money into the fund prior to 9/20/2008:

****All the Funds intend to apply to be insured under the program. Under the program, the U.S. Treasury will guarantee investors $1.00 per share for each share held on September 19, 2008 of any eligible money market mutual fund that participates. The program will last until December 18, 2008, after which the U.S. Treasury may elect to extend it for an additional period, but not beyond September 18, 2009. The guarantee under the program could be triggered if a Fund’s net asset value falls below $0.995, commonly referred to as breaking the buck.****

I’m still scared for the worst right now. Maybe you can set my mind at ease about these, because the actual yields are tremendous.

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avatar 8 Anonymous

Isnt it true that the rate that Vanguard posts for money market funds are “NET of all the funds’ expenses fees”??? How about the same for Fidelity, TRowe, and others?

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avatar 9 Luke Landes

SavingEverything: That is true for all funds, the money market yields are after fees.

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avatar 10 Anonymous


You should give the ETF “VTI” a look. It’s also a Vanguard total stock market etf and has half the annual expense of the one you’re in.

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avatar 11 Anonymous

#1: Timing the market is a sucker’s bet. It might be fun, but don’t fool yourself – you’re not investing, you’re gambling. In an earlier post you asked “Is it too risky to try to time the market right now?” The answer is – it’s never a good time to try to time the market. Buy and hold.

#2: Costs matter. By buying and selling index funds through an ETF you’re significantly reducing your returns through transaction fees and short-term capital gains taxes. As John Bogle says, you’re “frustrating the original purpose of the index strategy – efficient long-term investing in a diversified portfolio of businesses – giving [you] instead a vehicle for short-term speculation in the stock market.”

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avatar 12 Anonymous

I invested in Dreyfus Preferred New Jersey Tax Exempt Bond fund. The fund has dropped big time and I have lost
thousands of dollars I am considering cutting my loses…before I lose more money. While I had planned to stay in the
fund for a short time I had not expected to remain in this fund for years….it seems to me that now I would have to
remain in for a longer term of years and hope that the fund comes back up. Now I am worried that the fund will drop
even lower and I will lose additional thousands…While I am in a high tax bracket and the tax exempt fund has been
yielding around 3% yields I am seeing my principle falling.

Why I keep asking myself is the fund dropping? Are people selling in a panic? Are they worried that the towns will not
pay their debt? Any suggestons? Thx

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avatar 13 Anonymous

Am I missing something? I just Vanguard’s rate on their Tax Exempt Money Market account and it is listed at 1.54 average 7-day annualized (11/10/2008). Have the rates dropped that much since October?

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avatar 14 Luke Landes

Doug: Yes the interest rate of this tax-exempt money market fund has dropped dramatically since the beginning of October.

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