You might see people mention Money Funds, MMFs, or Money Market Funds online or in-person. Well they’re all the same, just different names that people may call Money Market Funds. Just make sure you don’t get it mixed up with MMAs, since that is a whole different thing. Money funds are a type of mutual fund, focusing on low-risk and short-term investing. There are a plethora of Money Funds you can purchase: Government Money Funds, Municipal Money Funds, and Prime Money Funds. They’ll all have different benefits, so be sure to read thoroughly to see which ones are perfect for you to purchase.

What are money market funds?

Money funds can be divided into two categories: Taxable and Tax-exempt. Let’s first discuss the difference between these two categories. Taxable money funds require you to pay federal taxes on dividends earned, along with state and local taxes. However, not all states will require state and local taxes, as you may be exempted to one of those. They typically offer higher yields than tax-exempt funds, with the downsides of taxes on any income made. Tax-exempt money funds don’t require you to pay federal taxes on dividends earned, however you may still have to pay state and local taxes. They may not pay as much, but they offer tax-exempt earnings.

You might think that you should always pick the tax-exempt money funds, but recall back to how Traditional and Roth IRA accounts work and how their differing tax benefits may apply. Taxable money funds are great for people starting out and are in a lower tax bracket. This is because you’re taxed less on average, therefore the money you would save on tax-exempt money funds is marginal to none. On the other hand, tax-exempt money funds are great for those in higher tax brackets, as you’re saving a lot more money by not needing to pay many taxes.

Types of Money Market Funds

Taxable Money Market Funds

Government Money funds

Purchased through a managed portfolio, in which you can buy government treasury bills and notes through a bank or firm.
Taxed at the federal level, but are usually exempt from state and local taxes. This only applies if it’s investing U.S. Treasury or federal agency securities.
Government Funds invests mostly in cash and government/agency debt, which offers lower risk but lower yield since it’s safe and highly liquid.

Prime Money Funds

Also referred to as Corporate Money Funds, in which you purchase market securities issued by companies in the United States or abroad.
Taxed at the federal, state, and local level since they are investing in corporate and bank debt, rather than the government.
Since it’s not backed by the government, it has low to moderate risk, but offers higher yields than Government Money Funds.

Tax-Exempt Money Market Funds

MUNICIPAL Money funds

Securities that are issued by the state and local governments and may be purchased with the benefit of being exempt from state and local taxes.
They are highly liquid and low risk investments, but typically offer lower yield to compensate its safety.

An important note to consider is that you can organize them into these blanket subcategories of Municipal Money Funds: Federal Tax-Exempt, Double Tax-Exempt, and Triple Tax-Exempt.

Federal Tax-Exempt money funds are issued by various states, countries, cities, and towns. They tend to invest in securities from differing issuers and in differing regions, which helps reduce risk. Interest is federally tax-exempt, but they are often subject to state, and sometimes local, income taxes.
Double Tax-Exempt money funds are instruments that invest in a single state but to multiple cities and utilities. This helps diversify the risk, but they aren’t as diversified as they are primarily in one state. Think of them like a state-specific municipal money fund, in which they are exempt from federal taxes and state income taxes if the investor is a resident of that state.
Triple Tax-Exempt money funds only really apply to states that have local income taxes. Not all states do, in which you can visit this website to see which ones these apply to. Even then, this category gets more complicated as not all cities treat municipal interest the same. Some local taxes apply to wages and some exempt all interest income. Regardless, this type of money fund is exempt from federal, state, and local income taxes, but this is quite uncommon.

Some municipal money market funds may generate interest subject to the federal alternative minimum tax (AMT) due to holdings of private activity bonds. Another thing is that if a fund holds out of state municipal securities, that portion of income may be taxable at the investor’s state level.

How do They work?

Their true value is how stable they are and how they are invested. Almost all money funds try to maintain their Net Asset Value (NAV), which is $1 per share, making them affordable and only positively growing your earnings. Despite that similarity, the yields offered from money funds vary, so be sure to see all the options before you purchase.

When you purchase your shares, your money is pooled with a bunch of others to an investor that will diversify your money into the differing money funds. This is to help reduce risk when you invest, as there is always a chance to lose your money in the off chance the NAV goes below $1.

Money Market funds