David Jelinek: I’m looking at opening a tax-free money market account. Let’s say the going rate for taxable money market funds is 4.75% and that I’m in the 36% federal bracket. That means that my goal is to find a tax-free MM account yielding at least 4.75% * (1-.36), or at least 3.04%.

Now here are a few issues:

1. When I find the yield for a tax-free MM acct, that yield isn’t going to stay the same. So how do I judge? Should I just make a decision based on the current taxable and tax-free yields and figure they’ll stay about the same relative to one another?

☞ Yes. That’s a reasonable, if imperfect, assumption.

2. Should I even bother getting a tax-free MM acct in the first place? Maybe I’ll beat that 3.04% figure by 40 or 50 basis points if I’m lucky. Do you think that’s really worth it?

☞ No. No one should ordinarily keep huge amounts in a money market fund, and therefore, the difference in absolute dollars is pretty trivial, and not worth your time worrying about. Fifty basis points on $10,000 is $50.

3. It’s aggravating to think that I won’t even keep pace with inflation. I hate the way the tax code works.

☞ It’s much better in Burundi. Well, on balance, maybe not. To beat inflation safely and with a tax advantage, consider Series I savings bonds.

4. I found something very puzzling about the whole performance vs. expense ratio deal: According to imoneynet.com, two of the best performing tax-free MM funds are Strong Municipal MMF and Vanguard Tax-Exempt MMF. As it happens, Strong has beaten Vanguard every year since 1994 (which is the earliest year for which I have data). And yet, Strong’s total expenses total a whopping 1.1% while Vanguard totals .34% !!!

☞ You are reading the numbers wrong – adding the management fee to the expense ratio. Actually, the management fee is part of the expense ratio. Based on the web sites you linked me to, Strong’s municipal money market expense ratio is 0.6% and Vanguard’s is 0.18%.

So Strong is consistently outperforming Vanguard by about 1% every year before expenses!?! Is the muni market THAT inefficient? What the heck is going on here?

☞ I haven’t studied it, but Strong may be taking a little more risk in the nature of the securities it will buy and the length of maturities it will accept.

What do you do for a money market account?

☞ I don’t pay much attention to this. I just use the ones that come linked with my brokerage accounts.


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