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Publish date: Ratings: Shop for Money Market Funds

The difference between high- and low-rated funds adds up over time.

Yes, investor, there are differences in money market funds -- enough to potentially reward a person making a careful choice with a five-figure retirement vacation. Tax-free, to boot!

A study of taxable and tax-exempt money market funds found that choosing those with TheStreet.Com Ratings at the high end of the scale produces returns superior enough over bottom-rated funds to generate an extra $19,768 on a $10,000 investment over a person's working years, assuming rates remained at current levels.

An investor's research into a mutual fund provider usually focuses entirely on stock- and bond-fund offerings. The money market choice is reduced to an afterthought. "Well, I have to park the cash someplace" is a typical attitude. People don't realize that the quality of the "parking spot" can add up to a significant payoff over time.

Just as many consumers automatically say "OK" to the extended warranty on their new TV, they put their money into any money market fund their advisor places in front of them. But just as the extended warrantees often have some of the highest profit margins to the consumer-electronics retailers, some money market funds seem to be better deals for the brokerage house than for the investor.

A money market mutual fund is a collection of very liquid fixed-income investments with an average maturity of 90 days or less. The net asset values of shares are held steady at $1 and dividends are passed along to investors, net of fees that are far smaller than those common in stock mutual funds. Ratings ranks money market mutual funds based on both their volatility and returns. With total return, net of fees, the more the better. But with volatility, less is better. Attempts to juice returns by adding investments that are riskier or have longer maturities tend to increase the volatility of returns, leading to lower ratings. So picking a top-rated fund won't necessarily produce the highest possible return, but it will produce a better return than choosing a low-rated fund without exposing an investor to unnecessary volatility.

The accompanying tables compare one-year total investment returns and current dividend yields on the 10 money market funds with the highest and lowest Ratings scores in both the taxable and tax-exempt classifications. These results make crystal clear the advantages of keeping excess cash in higher-rated money market funds.

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These advantages are not to be taken lightly, as they can translate into a couple of percentage points of additional yield. As some economists are so fond of saying: " ... those little percentage points, working 24 hours a day seven days a week, given some time, can add up to some impressive results."

Extra $19,768 in Retirement

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Source: Ratings

For example, if a person in his or her 20s were to put aside $10,000 as a reserve in a taxable money market account at the current average dividend yield for the top-10 money funds (4.72%), he or she would have $50,239, before taxes, in ready cash at retirement 35 years later. At the bottom-10's average dividend yield of 3.68%, a person would accumulate just $35,426 after 35 years. The $14,813 difference produced by choosing a top-rated money market fund rather than a bottom-rated one could pay for a nice vacation to start off the person's retirement.

The differences between best and worst are even greater when looking at tax-exempt money market funds. Comparable figures for tax-free money market funds are $43,500 for $10,000 at the average dividend yield of 4.29% for top-rated funds, vs. $23,732 for bottom-rated funds at 2.50%. That works out to a relatively risk-free (and tax-free!) retirement bonus of $19,768 for the person who chooses top-rated municipal money market funds. Be sure to check with your tax adviser to learn which taxes do or do not apply to money market funds that invest in municipal bonds. Where you live can make a significant difference in taxes owed.

Of course, interest rates change over time, so no one knows what the precise returns on these funds will be in the future. But doing some comparison shopping to select a money market fund that offers an additional percentage point or more of yield can easily turn into an impressive bonus down the line.

Prior to joining Ratings, Widows was senior product manager for quantitative analytics at Thomson Financial. After receiving an M.B.A. from Santa Clara University in California, his career included development of investment information systems at data firms, including the Lipper division of Reuters. His international experience includes assignments in the U.K. and East Asia.

Kevin Baker became the senior financial analyst for TSC Ratings upon the August 2006 acquisition of Weiss Ratings by, covering mutual funds. He joined the Weiss Group in 1997 as a banking and brokerage analyst. In 1999, he created the Weiss Group's first ratings to gauge the level of risk in U.S. equities. Baker received a B.S. degree in management from Rensselaer Polytechnic Institute and an M.B.A. with a finance specialization from Nova Southeastern University.