Settling Down With a Money Market Portfolio

The yields paid by money market mutual funds have doubled in little more than a year, turning what was for many a temporary spot to store money into a place with a comfortable, inflation-beating return.

Money market portfolios are the yeomen of the mutual fund world. They’re dependable, hard-working and don’t cost much. They deliver competitive short-term yields with virtually no price risk.

Today, you can find money funds paying 6% or more, after expenses. Rates on some tax-free products now exceed 4%.

Money funds invest in government, corporate or municipal debt with short-term maturities--primarily IOUs coming due within 90 days. As holdings mature, proceeds are rolled into new investments bearing higher or lower yields, depending on market conditions. The funds themselves don’t mature.

By sticking with such short-term investments, money funds rarely sustain capital losses, nor do they realize gains. Consequently, they maintain a constant price or “net asset value” of $1 a share.

What do you need to know about money funds? Not as much as with stock or bond mutual funds, both of which are more complex. But some pointers are worth heeding:

* Money funds can drop in value. Really. And the funds do not carry federal deposit insurance. In more than two decades, only one money fund has suffered a loss--and that was a portfolio designed for institutional investors that dabbled in derivatives--but there have been several close calls.

* It’s unclear how far fund groups will go to absorb losses on money funds and keep their prices from “breaking a buck,” or falling below $1 a share.

“Most mutual fund management companies will do everything possible to avoid breaking a buck, short of going bankrupt themselves,” says Amy O’Donnell, who manages four money funds for the Benham Group in Mountain View, Calif.

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But in a February survey of 23 large fund groups by IBC/Donoghue of Ashland, Mass., only three companies gave such an unequivocal pledge. They are San Francisco-based Charles Schwab and two San Antonio firms--United Services and USAA.

* Unlike some stock and bond mutual funds, money market products are never sold with a load or sales charge. Their yields are too skimpy to justify that.

But they do have other expenses. You might, for instance, face a “12b-1” fee that could be as much as 0.5% a year on broker-sold funds. Any such fee would be included in total expenses, which are deducted from yields and can range above 1% annually. On average, though, money funds charge only about 0.6% a year in expenses.

* Fee waivers can give your fund a nice if temporary boost. More than half of all fund companies now waive part or all of their management fees as a way to increase yields and entice investors. But these typically don’t last indefinitely, and they will probably evaporate more quickly now that rates are rising again.

* Higher yielding funds often have high minimums. Some of the top funds require minimum investments of as much as $2 million--and they are often involved in riskier investments.

* Many money funds use derivatives, but these esoteric investments are not easy for shareholders to recognize. Nor do all derivatives carry the same risks.

O’Donnell suggests that investors look for a clear explanation of management’s derivatives policy in the shareholder reports or prospectus--and advises avoiding funds lacking a good explanation.

* California tax-free money funds are not compelling buys right now for investors in medium or lower tax brackets.

Regular money funds, currently yielding 5.6% on average, are more enticing for mainstream investors.

* Money market funds are pretty homogeneous, all things considered, so it doesn’t pay to spend a lot of time shopping around.

You should select a fund group primarily on the basis of its stock and bond products, which carry a lot more upside potential and risks. Unless a firm’s money fund shows an obvious red flag such as excessive costs or a murky derivatives policy, don’t hesitate to use it.

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Dramatic Turn

The yields paid by money market mutual funds have doubled within the past year and now exceed the inflation rate by two percentage points. Average annualized yields paid by taxable money funds in recent months: (see newspaper for graphic)

1993: 2.65% 1995: 5.43%

Source: IBC/Donoghue’s Money Fund Report

* FUND LISTING

A selection of larger and higher-yielding money market funds appears in The Times on Thursdays.