Money market funds are diversified portfolios that are composed of short-term securities of creditworthy corporations, banks and other financial institutions, and federal, state, and local governments. U.S. Treasury bills and bank certificates of deposit, for example, are common holdings of money market funds.
There are two distinct categories of money market funds. So-called taxable money market funds pay dividends that are subject to federal, and possibly state and local, income taxes. Taxable money market funds include:
* U.S. Treasury Funds invest primarily in direct U.S. Treasury obligations whose principal and interest payments are backed by the "full faith and credit" of the U.S. government.
* U.S. Government Funds hold high-quality obligations of the U.S. Treasury as well as agencies of the U.S. government.
* General Purpose Funds invest in the short-term debt of large, high-quality corporations and banks.
The second category of money market funds is known as tax-exempt or municipal money market funds. Tax-exempt funds invest in short-term securities of state and local government agencies, and provide dividend income that is tax-free.
There are two basic types:
* National Tax-exempt Funds invest in municipal obligations issued by state and local governments around the country. Such funds provide income that is free of federal income taxes.
* Single State Tax-Exempt Funds hold municipal obligations issued by state and local governments of a particular state. Such funds provide income that is free of federal as well as state and local taxes.