Safest Mutual Funds

The safest mutual funds have a great track record for safety, and they pay interest in the form of dividends. They have a share price that is pegged at $1, which does not fluctuate like the share price of other mutual funds. Trillions of investor dollars have been safely invested in these money market funds over the years.

In 2008-2009 millions of investors took major losses in mutual funds, and many of them made a false conclusion: that mutual funds in general are risky investments. This is not the case. Stock funds involve considerable risk, and longer-term bond funds come with moderate risk. Unfortunately, many investors had most of their investment assets in stock funds in 2007, and continued to hold them as the stock market tumbled.

High quality short-term bond funds involve less risk and money market funds (MMFs) are at the top of the list for safe mutual funds. If you want safety and/or are putting money aside for a shorter-term goal like college funding or to accumulate a down payment to buy real estate, consider investing in both of these fund types.

If you want to add safety to your retirement portfolio, hold these funds along side your stock funds and other investments.

Both bond funds (also called income funds) and money market funds pay interest in the form of dividends. These dividends are normally subject to income tax unless the fund is held in a tax-qualified plan (like a 401k or IRA). In this case the income from dividends is either tax deferred or tax free.

There are also tax-exempt (tax-free) income funds and MMFs designed for folks in higher tax brackets. These invest in municipal securities issued by government entities like the State of Ohio. The interest paid to investors (dividends) is free from federal income tax.

Traditional (taxable) money market funds and income funds invest in debt securities (IOUs) of the federal government, banks, and other corporations. Now, here's the difference between money market funds and bond or income funds, including short-term income funds.

All bonds and income funds come with interest rate risk. In simple terms this means that if you hold them you will lose money if interest rates in the economy go up. This risk is highest for long-term bonds and funds, and much lower for quality short-term bonds and short-term income funds, which are the safest bond funds.

The advantage of bonds (and funds that invest in them) is that they pay higher interest (dividends). Long-term income funds pay the most, and short-term bond funds pay the least. Generally, these short-term income funds pay a bit more in dividends than money market funds.

The traditional money market fund (MMF) invests in high quality short-term IOUs issued by the federal government (T-bills), banks and other major corporations. This short term debt is of very high quality and generally matures in a matter of weeks or months. This arena of investments is referred to as the money market.

Because of the short term nature of these securities, an MMF is continually replacing those securities that have matured with new ones at current competitive interest rates. Hence, as interest rates go up, so do the dividends for the fund. When interest rates fall, fund dividends do as well.

Due to the short term nature of their holdings, these funds have virtually no interest rate risk; and since their holdings are of such high quality there should be very little investment risk to be concerned with.

You can earn competitive interest rates by simply holding an MMF, with very little risk of losing money.

In the early 1980's investors earned double digit returns in money market funds because interest rates were at historical highs. Unfortunately, 2008-2009 ushered in a period of historically low interest rates, and MMF returns followed suite.

When rates rise, the dividends for these safest of mutual funds should as well.

A retired financial planner, James Leitz has an MBA (finance) and 35 years of investing experience. For 20 years he advised individual investors, working directly with them helping them to reach their financial goals.