Question: Please tell me how some money market funds reguarly pay higher interest than others. Do their investments involve higher risks or perhaps more limitations on the investor?
Answer: The correct answer is "none of the above." Most money market funds place their money in essentially the same kinds of investments. Risk is about the same for all of them -- very low, in my opinion.
Restrictions on investors vary somewhat among the funds, but these limitations -- such as minimum investment size -- have no practical effect on the yield.
The major difference between funds is in their investment decisions, particularly with regard to market timing.
In a period of rising interest rates, the objective is to invest in short-term financial paper. That makes it possible to turn over the funds frequently to take advantage of increasing yields.
When interest rates are falling, the reverse is true. The smart money manager tries to lock up current high rates for a longer period of time, because maturity and subsequent reinvestment will bring a lower yield.
So the differences in yields among the funds result from individual success in reading the future course of interest rates and in having access to a variety of money market instruments of different maturity lengths.
If rates are rising, the return from a fund whose managers had anticipated a drop and therefore were locked up in long-term paper would lag the fund with greater short-term flexibility. And, to coin a cliche, vice versa.
But if interest rates stabilized for any length of time, you would soon see the yields from the various funds settle down much closer to each other.
q: We purchased a one-third interest in a vacation-area condominium as an investment. We intend to restrict our use to the allowed 14-day period to retain the business aspect for tax considerations. Can each of the three owners use the condo for 14 days without risk of losing the tax benefits :
A: No. The 14-day limitation applies to the combined personal use by all owners and their families.
However, there is an alternative limitation that might help a little. You are allowed personal use of the property for either 14 days or 10 percent of the total number of days it was rented (at a fair market value), whichever is greater.
So if the condo was rented for 210 days during the year, you (and the other owners) would be permitted to use the property for up to 21 days without jeopardizing your tax deductions.
The problem, of course, is knowing in advance how many days of rental you will end up with. To be safe, better stay with a combined total of 14 days until near the end of the year.
Q: My wife and I are planning the purchase of our first house. We have one child, so we're entitled to a total of three exemptions on our income tax. Can we legally claim 10 exemptions, in anticipation of a much lower tax because of the purchae of the house and the resulting deductions for interest and taxes?
A: You are permitted to claim additional allowances to reduce the amount of tax withheld from your pay when you expect to have substantial Schedule A dedictions.
However, you don't arbitarily pick a number like "10" out of a hat. Form W-4 -- the Employee's Withholding Allowance Certificate that you file with your employer -- has a worksheet and instructions to help you decide on the appropriate number of allowances to claim.
Included on the worksheet is a section for estimating the total deductions you expect to claim in excess of a specified amount that the IRS considers normal for various work and family situations.
Dividing this estimated excess by 1,000 gives you a ballpark figure for the number of allowances to claim over your normal family exemptions.
There is also a place to include additional allowances if you expect your tax to be reduced significantly by such things as the residential energy credit or the credit for child care expenses.
Although over-withholding in effect gives the government an interest-free loan for some months, the IRS makes it quite clear that you are not expected to have more money withheld from your pay than is needed to meet your anticipated tax liability.
So if your personal circumstances change in a way that foreshadows a lower tax than before, you should immediately file a new Form W-4 with your employer.