Which Vanguard Money Market Fund?

April 10, 2007 by TFB

[Last updated on April 20, 2008. Special thanks to Ron Lieber and Ari Weinberg at FiLife for suggesting clarifications. Added info on Vanguard Federal Money Market Fund and Schwab AMT Tax-Free Money Market Funds.]

I mentioned in my simplifying finances post that I use a Vanguard money market fund instead of an online savings account for my short term savings. I use a Vanguard money market fund for simplicity and because it gives me a higher yield after tax. Vanguard offers 4 taxable money market funds and 6 tax exempt money market funds. Which one do you choose?

They are all good. The main difference among the 10 Vanguard money market funds is how the funds' income is taxed at the federal and state level. Which one will be slightly better than others for you depends on your federal and state marginal income tax brackets, whether you itemize state income tax deductions, whether you will pay the Alternative Minimum Tax (AMT), and the percentage of the fund's income derived from private activity bonds subject to the AMT.

The income from money market funds may be called "dividends" but it is really just interest. It doesn't get the special tax treatment for qualified dividends.

1. Vanguard Prime Money Market Fund (VMMXX). The income from this fund is taxed at both the federal level and the state level.

There is also a Vanguard Federal Money Market Fund (VMFXX). For customers in California, Connecticut and New York, the Federal fund is also fully taxable at both the federal level and the state level, just like the Prime fund. For customers in other states, about 20-25% of the income from the Federal fund is taxed at the federal level but not at the state level; the other 75-80% of the income is fully taxable at both levels.

2. Vanguard Treasury Money Market Fund (VMPXX) and Vanguard Admiral Treasury Money Market Fund (VUSXX). The income from these two funds are taxed at the federal level, but not taxed at the state level. The difference between the regular fund VMPXX and the Admiral fund VUSXX is that the Admiral fund is cheaper by 0.16% and it requires a $50,000 minimum investment versus $3,000 for the regular fund.

3. Vanguard Tax-Exempt Money Market Fund (VMSXX). The income from this fund is not taxed at the federal level, but a majority of it is taxed at the state level. Income from private activity bonds in the fund is subject to the Alternative Minimum Tax (AMT).

4. Vanguard state-specific Tax-Exempt Money Market Funds. There are five of these, for taxpayers in CA, NJ, NY, OH, and PA. If you are a New Jersey taxpayer and you buy the Vanguard NJ Tax-Exempt Money Market Fund, the fund's yield is taxed neither at the federal level nor at the state level. These funds are sometimes referred to as "double tax free" funds. Income from private activity bonds in these funds is subject to the Alternative Minimum Tax (AMT). If you don't live in these five states, then there's no point in buying these. Consider instead the national tax exempt fund Vanguard Tax-Exempt Money Market Fund (VMSXX).

5. AMT Tax-Free Money Market Funds. If you pay AMT, a state specific tax exempt money market fund that doesn't invest in private activity bonds may yield higher for you after tax. Income from these funds is exempt from AMT. Unfortunately Vanguard doesn't offer this kind of funds. Fidelity and Schwab are the only places I know that have them. Fidelity has these funds for four states: CA, MA, NJ, and NY. The minimum initial purchase is $25,000, although you can drop down to $10,000 after the initial purchase. Schwab also has funds for the same four states, but Schwab's funds are in general more expensive than Fidelity's.

In order to calculate which fund pays the highest yield after all taxes are taken into consideration, first you have to know what the funds pay before tax. Vanguard provides this information on their web site. For example here's a snapshot for the Vanguard Prime Money Market Fund as of April 5, 2007:

The Compound Yield is comparable to how the banks calculate APY. It is a net compound yield, after expenses are taken out — don't worry about the expense ratio number listed under the compound yield because it is already included in the calculation for the compound yield.

If you will pay the AMT and you are considering tax exempt funds, you will also need to know the % of fund's income from private activity bonds, which is subject to the AMT. Vanguard provides that information in the Holdings section for the fund. For example, here's what Vanguard gave for Vanguard New Jersey Tax-Exempt Money Market Fund (VNJXX):

Fidelity lists the yield for their AMT Tax-Free Money Market funds on their website. You will need the "7-Day Effective Yield %" number.

After you gathered all the inputs, it's time to crank the numbers. I made a calculator for computing both the bottom line, after tax yield and the tax equivalent yield. The fund with the highest after tax yield puts the most money in your pocket after all taxes are paid. You get to see how much difference your choice really makes (sometimes very small, to the tune of less than $1 per $10,000). The tax equivalent yield is comparable to the APY quoted by bank savings accounts.

Although this post is about selecting among Vanguard money market funds and Fidelity's AMT free money market funds, the calculator is generic. You can use it for money market funds offered by any company. You can even use it for regular bond funds, although selecting a bond fund will involve more consideration than just yield.

If the inline frame doesn't come up for you, please access it directly from the hosting site.

For example, at the time I wrote this post, a taxpayer in 25% federal, 6.37% state tax brackets, itemizing deductions, not subject to AMT, is better off with the Treasury or Admiral Treasury fund.

Who knew choosing a money market fund can get so complex?

Comments

23 Comments on Which Vanguard Money Market Fund?

Cents You Asked on April 10, 2007 | permalink

Great post! I wish I had read this before setting up my Vanguard Prime MM. I'm going after the same simplification idea that you are and so far I love it all being in one place. Best of luck!
Anonymous on April 13, 2007 | permalink

tfb,
Your work here, and your posts on the Diehards forum, are very helpful and much appreciated. Thanks!
Shadox on April 16, 2007 | permalink

This is a superb post! I have posted a link to it on my blog.

You are now on my list of favorite PF bloggers.
FIRE Finance on April 25, 2007 | permalink

This is a fine post, we have cited it as one of our favorites in our weekly
carnival round up. Keep up the great work.
Cheers,
FIRE Finance
Anonymous on September 16, 2007 | permalink

the calculator is offline today

I just realized that money market funds give off dividends which are taxed at a significantly lower rate than regular income. I dont remember if you took that into consideration in your calculator…

thanks, theo
Anonymous on September 16, 2007 | permalink

calculator back online. hosting site was down for a while…

i also realized that although MMF distributions are called dividends, they are taxed at your marginal tax rate (i guess they are not qualified dividends?).

oh well…
Anonymous on September 26, 2007 | permalink

I don't think you are right about VMPXX and VUSXX being non taxable at state level. It is true that a greater portion of the fund assets are invested in Tresury securities but that does not mean they will be exempted from state taxes. I just read the fund pages on Vangurad. For other securities they specificly say that this fund is not taxable at federal level (example vanguard tax exempt money market fund). Would you comment and clarify this please? In my case your calculator gives me Tresury as the best option if it was state tax exempt but before I take steps I would like to understand it better
TFB on September 26, 2007 | permalink

@anonymous re: state tax exempt status for Vanguard Treasury Money Market Fund (VMPXX) and Vanguard Admiral Treasury Money Market Fund (VUSXX).

1) Treasury bonds are exempt from state and local income tax. That's the law. See 31 USC 3124(a).

2) VMPXX and VUSXX invests nearly 100% in Treasury bills and Treasury notes. See latest semi-annual reports for VMPXX and VUSXX.
Anonymous on September 27, 2007 | permalink

I know VMPXX and VUSXX invest nearly 100% in treasury. I also know treasuries are exempt from income tax. But the word nearly is important in my opinion. I would probably call Vangurad to find out for sure. However, one question I would raise, Why they would list VMPXX and VUSXX in the Taxable money market instead of listing them with Tax exempt nature. For example they have listed short term munis in the short term tax exempt section. If you look at the holdings, you will find out the only differece between 3 different kind of money market is the spread in the credit quality of the issuers. So what I think is you can invest in any of three types of taxable MMF but you have to pay in terms of yield to get to NEARLY pure top rated credit quality AAA.
TFB on September 27, 2007 | permalink

Did you follow the links I gave in (2) in my previous comment? They showed VMPXX was 100% in Treasury, VUSXX 99.8% in Treasury. The taxable versus tax-exempt label in Vanguard means taxable or tax exempt at the federal level.
Ari on October 5, 2007 | permalink

Great post and great site. Thanks for the FiLife nod.

One thing I recently came across: Tax-exempt yield isn't always what it seems. The Alpine Municipal MMF, with a yield of 3.93% (10/4) derives almost 67% of income from securities subject to AMT.

Seems rather counterintuitive given the expanding reach of the AMT.
Anonymous on February 28, 2008 | permalink

hello TFB,
looking for some advice,
im debating on the vanguard Prime MMA or the NY tax exempt. which would you think is better for me?
im 24, filing single. thanks ~
TFB on February 28, 2008 | permalink

What does the calculator say? This post and the calculator were made to help you compare yield between two funds. Choose whichever fund offers the higher after tax yield to you.
Anonymous on April 10, 2008 | permalink

tfb,

Thanks again for this post. I used it a year ago to make some decisions on where I was keeping my MM funds. Now it's a year later and MM rates have dropped like a stone. I'm glad I made the moves I did – especially after recently filling out my tax paperwork.

-John
Nifty News & Decent Deals
Nate on September 5, 2008 | permalink

I'm considering I-bonds, which currently offer 2.42% yield which is exempt from state taxes.

In the calculator above should I put the yield in "State-Specific Tax Exempt"?
TFB on September 5, 2008 | permalink

Nate – I-Bonds are most similar to Treasurys.
Cate on October 6, 2008 | permalink

I spent almost a week trying to get our money out of Vanguard. We had the account for over 20 years. I would never – no never trust this company AGAIN. If you use them rest assured you do so just as if they were a brokerage house – consider it money you can well afford to lose. Otherwise, don't invest with them. It took the
threat of a Court Order to force them to release the money; meanwhile telling them that I know where the press room in the courthouse is so that the associated press would be sure to get word of what they were doing to us. The only other company that acts like this is Merrill Lynch.
zanon on February 13, 2009 | permalink

TFB: Would you still recommend the CA fund given California's economic situation? They will probably be bailed out by the Fed, but still, if there's any state on the verge of default it's CA.
TFB on February 13, 2009 | permalink

zanon – I don't think I ever recommended any fund. The purpose of this post was to provide a tool to compare the bottom-line yield. My thoughts on risk are in this follow-up post: Risks in Money Market Funds.
zanon on February 13, 2009 | permalink

Sorry TFB — you are right, there was no recommendation.

Thanks for the follow-up link.

Love the site!
Samples on April 2, 2009 | permalink

How much does the historical yield (which is what we're calculating from) correlate to an expected future yield for these funds? Obviously nobody knows the exact answer, but do they tend to move up and down in a similar ratio that would leave one to believe the better fund for you now based on the calculator will be the better fund for you tomorrow?
TFB on April 2, 2009 | permalink

Samples – They tend to move up and down in the same direction but not in a similar ratio. The best today can be 2nd best a few months from now. If the difference isn't large, it's worth switching. If there is substantial difference, then I switch. There is no cost for switching. So I just redo the calculation with the current rates once in a few months.
Amit Mehta on April 14, 2009 | permalink

Great Post! You are doing a fantastic service to all of us.