The more the Fed cuts short-term interest rates, the more attractive tax-free money-market funds become, reports Kiplinger's Personal Finance Magazine.
The Fed's actions have sent yields on taxable-money-fund staples, like Treasury bills and short-term federal agency debt, plunging. The average taxable fund now pays 4.6 percent, equivalent to a 3.4 percent net yield in the 28 percent bracket. The comparable return on tax-exempt money funds has been drifting around 3.8 percent since last summer and has risen above 4 percent from time to time.The advantage for tax-free funds should persist. Cash-strapped cities and states often have no choice but to flood the market with new issues, thus driving rates up. In addition, the market for these funds is inefficient and confused, says Mary Metastasio, manager of SAFECO Tax-Free Money Market Fund, in Seattle. It's difficult to set value as precisely as with T-bills, and fund managers have more opportunities to improve yields.
Safety may be an issue for a handful of tax-free funds, but their bonds are often insured or backed by a bank. Plus, the chance of loss is small because funds invest in so many cities and states.