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Tax Exempt Money Market Funds: VMSXX
Posted By Jim On 10/20/2008 @ 7:55 am In Investing | 7 Comments
When I compiled a list of high yield savings accounts rates , a reader mentioned that tax exempt money market funds blow all those returns out of the water. He was totally right. In fact, I have a portion of our savings invested (I say invested because your principal is not protected by FDIC insurance in a money market fund) in Vanguard’s Tax Exempt Money Market Fund (VMSXX  [Google Finance: VMSXX ]).
The Vanguard’s Tax Exempt Money Market, and in general all tax exempt money market funds, seeks to maintain the $1 share price while generating a return using very safe assets. Specifically, they invest in “short-term, high-quality municipal securities issued by state and local governments across the United States.” That’s how they can guarantee that the earnings are exempt from federal personal income tax. With VMSXX, they invest in securities that are a year or shorter and a dollar weighted average of 37 days (as of this writing). You’ll find that most funds are structured this way regardless of the company. I am using Vanguard as an example because I have my money there.
Since the yield is exempt from taxes, it’s not fair to compare them to other investments without some additional math to account for the tax exempt status. The easiest way is to find out which marginal tax bracket  you’re in and divide the yield by (1 – marginal tax bracket).
If I’m in the 25% tax bracket and I want to find the taxable equivalent yield of an asset with a yield of 4%, I divide 4.0 by 0.75 = 5.33%. A tax exempt security yielding 4.0% is the equivalent of a taxable security yielding 5.33%. That 25% tax really takes a big chunk out of that return, huh? That’s why tax exempt securities are so attractive.
You can use this simple tax equivalent yield calculator  to help you do the math.
Some things to keep in mind about money market funds:
If you want to get another opinion, Nickel also put some money in VMSXX and wrote about his experiences with the tax exempt money market funds .
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 high yield savings accounts rates: http://www.bargaineering.com/articles/high-yield-savings-accounts-rates.html
 VMSXX: https://personal.vanguard.com/us/JSP/Funds/Profile/VGIFundProfile0045Content.jsf?tab=0&FundId=0045&FundIntExt=INT#hist::tab=0
 Google Finance: VMSXX: http://finance.google.com/finance?q=VMSXX
 marginal tax bracket: http://www.bargaineering.com/articles/2008-federal-income-tax-brackets-official-irs-figures.html
 tax equivalent yield calculator: http://www.bargaineering.com/articles/tax-equivalent-yield-calculator.html
 experiences with the tax exempt money market funds: http://www.fivecentnickel.com/2008/10/13/making-bank-with-the-vanguard-tax-exempt-money-market-fund/
Thank you for reading!