With money market funds recently posting annual returns upward of 4%, many mutual fund investors wonder whether they should choose these funds for part of their portfolio.

Factors to consider

First, you can’t look at the current return in isolation. You must deduct the inflation rate from a money market fund’s return to determine its real rate of return.

Second, you must consider the investment vehicle’s tax treatment. If a money market fund is in a Tax-Free Savings Account (TFSA) or First Home Savings Account (FHSA), no tax on investment returns is payable. But anywhere else, tax on money market fund earnings is payable at your marginal rate because money market returns are interest income.

Shorter-term savings

When money market funds earn higher returns, you have a new opportunity to save for a vacation, wedding, home improvements or any other short-term goal. Money market funds can also be valuable when you move to safety as a time horizon shortens, such as the last years of a Registered Education Savings Plan (RESP).

Long-term investing

Investing in money market funds for longterm investing is a case of “it depends.”

Say an individual invests in a money market fund with money they normally would have invested in the equity and bond markets. What happens if interest rates are falling a number of months down the road? That means a money market fund’s rate of return also falls, and this individual no longer wants to be invested in this low-earning fund. They want to resume investing in bonds and equities. But bonds do well when rates go down, and the investor has been missing out. If the stock market has also risen in the meantime, the individual must buy back in at higher prices. The potential risk is choosing short-term gains over longterm growth.

However, many long-term investors – especially conservative investors – may feel quite comfortable including money market investments as part of their fixed-income allocation when they can take advantage of higher returns.

Ultimately, whether or not to use a money market fund for long-term investing depends on each investor’s needs and risk tolerance, so it’s a decision to make with your advisor.