Wise Bread Picks

Last year I wrote an article about how I used my Vanguard Tax Exempt Money Market Fund as a high yield checkings account, and this week I suddenly got quite a few hits for that article.  So I wondered why that was and found that the yield for the tax exempt money market funds have shot up significantly.

The underlying investments for tax exempt money market funds are municipal short term debt also known as munis.  These are short term bonds or debt notes  issued by local governments to build things like schools and libraries.  The money earned from these munis are exempt from all federal taxes and also the state taxes of the locale where it is issued.  Usually, the money market funds that invest in these short term debts have lower yields than their taxable counterparts since investors get a higher tax equivalent yield.  However, the current situation is quite unusual and the yields have turned upside down.  For example, the Vanguard California Tax-Exempt Money Market Funds current yield is 4.66%, and that is nearly twice of the yield of the Vanguard Prime Money Market Fund.  Since the California Tax-Exempt Money Market Funds returns are not subject to state or federal taxes, 4.66% is equivalent to a taxable rate of more than 7% for someone in the 28% federal and 9.3% state tax brackets.  A better deal is in the Vanguard Pennsylvania Tax-Exempt Money Market Fund, which has a yield of 5.44% and equates to a pre-tax yield of more than 8% for some Pennsylvanians.    Needless to say, these yields are extremely high for tax exempt money market funds.

Why is this happening? This situation  is so unusual that Vanguard actually wrote an entire article explaining it .  The basic gist of the article is that since credit is tightening, municipal bond issuers have found that they need to increase their yields to attract investors.  Since Vanguard simply follows the market, they are getting better yields.

Are these investments safe?  Generally money market funds maintain their share values at $1.00 each, but recently we have seen a couple money market funds break the buck .  Even so, municipal debts are generally considered to be safe investments since they are backed by local governments and their tax bases.  Of course, local governments can go bankrupt so there is definitely a risk of default, but tax exempt money market funds generally have a portfolio of many different bonds from a collection of governments, so their risk is lower.

Finally, money market yields change everyday so no one knows how long these high yields will last.  However, since money market funds are as liquid as cash, you can always move your money when the yields go down.  For now, I really cannot find another safe investment vehicle that pays as high as these funds.

Disclosure:  I  own the Vanguard California Tax-Exempt Money Market Fund (VCTXX) and the Vanguard Prime Money Market Fund (VMMXX)