As the Federal Reserve pushes short-term interest rates higher, investors in money-market mutual funds don't mind a bit. You could say Chairman Alan Greenspan is giving them a raise.

For the 21 million-plus U.S. investors who own money-fund shares, interest-rate increases that take place now mean higher yields soon on their investments. The funds buy short-term, interest-bearing securities such as Treasury bills and commercial paper issued by corporations.

Since the start of 1999, the average seven-day compound yield on money funds has risen to 5 percent from 4.6 percent, according to IBC Financial Data Inc. in Massachusetts.

With the Fed's recent announcement of the third quarter-point increase since June in the overnight bank-lending rate, yields could well keep moving up. They usually follow trends in open-market interest rates with a lag of several weeks, as money-fund managers replace maturing securities with new ones carrying current market rates.

"Money-market funds are looking sweet," said Dan Wiener, who edits the newsletter Independent Adviser for Vanguard Investors.

In the past two years, assets of money funds have soared almost 50 percent, to more than $1.5 trillion, as tallied by the Investment Company Institute, the fund industry's biggest trade group. They account for one of every four dollars invested in funds of all types.

Money funds, sometimes known as "cash" in financial shorthand, have achieved that growth even though their yields can't begin to keep up with double-digit gains year after year in the stock market.

"Investors are racing to build their cash positions to keep pace with their stock positions," said Peter Crane, managing editor of IBC's Money Fund Report.

With net-asset values that don't fluctuate, money funds have become a favorite means of diversification for investors who want to keep riding the bull market in stocks as long as it lasts, but with stabilizers in place.

Although they are not covered by federal deposit insurance, money funds have established a reputation for safety. They're not subject to the price setbacks that hit most longer-term bonds and bond funds when interest rates rise, as they did in 1994 and again this year.

"Since 1994 money funds have been taking market share away from bond funds," Crane said. As recently as the end of 1993, bond funds held more assets than money funds. Now money funds are more than 75 percent bigger than the bond funds, which have about $830 billion.

Analysts often protest that bond funds earn better long-term returns than money funds. The Bloomberg average of more than 3,500 bond funds has gained an average of 6.8 percent annually over the last five years, beating money funds by 1.5 percentage points or more. Money-fund partisans aren't swayed.

Even investors who do like bond funds can use money funds as a counterweight, since the two types of funds tend to move in opposite directions as interest rates fluctuate.

The Fed's interest-rate increases this year came just as short-term rates and money-fund yields had begun to decline. The $38 billion Fidelity Cash Reserves Fund, the biggest of several money funds offered by the largest of all fund managers, Fidelity Investments, produced average annual yields in the 5.1 percent to 5.3 percent range through 1996, 1997 and 1998. For the past 12 months, its annual yield tailed off to 4.9 percent.

Now, though, it's climbing again and recently hit a 5.2 percent seven-day yield, according to IBC.

Among the other giants in the field, the $61 billion Merrill Lynch CMA Money Fund recently yielded 5.1 percent; Citigroup Inc.'s $44 billion Smith Barney Cash Portfolio class A shares yielded 5 percent, and the Vanguard Prime Money Market Fund yielded 5.3 percent.

"There are plenty of good reasons for owning a money-market fund regardless of its yield," said Wiener. "The check-writing privileges make them incredibly convenient, and cash is a good rainy-day asset."

If the yield on money funds does rise, though, so much the better for the people who own them. This year's increase of about two-fifths of a percentage point in yields, on a base of $1.5 trillion, puts an extra $6 billion a year in money fund shareholders' pockets.

Thanks, Mr. Greenspan.

Redemption woes

As you put money into any mutual fund, pay close attention to how you will get it out again.

Funds are known far and wide as highly liquid investments easy to enter or exit, usually the same day you decide to make a move.

Without this attribute, they wouldn't have enjoyed the spectacular success they have achieved in the 1990s, sextupling their assets to $6 trillion.

Sometimes, though, redemption takes longer than you expect, as when a transfer of an individual retirement account or other custodial account gets bogged down in paperwork.

And the fees! Many sellers of fund shares have been surprised by back-end sales charges, short-term redemption fees or account-closing fees.

Paul Roye, director of the division of investment management at the Securities and Exchange Commission, said exit fees and delays in IRA transfers are two common subjects of complaints the regulatory agency gets about funds.

In the midst of a bull market, exit doors that stick haven't caused a huge fuss. They could become a bigger bone of contention, though, if the financial climate gets less friendly and many people decide to cash out.

To learn the basics of how to redeem shares from any fund, look in the prospectus. If this document is somehow missing from your files, a copy can be found on many funds' Web sites or you can check with a fund group's telephone reps or an adviser through whom you invest. Each fund firm has its own rules for redeeming shares and closing accounts.

The stated purpose of restrictions is to minimize the impact of large outflows on the fund. Managers say it disrupts their efforts to maintain consistent results if big waves of shareholders' money keep sloshing in and out.

To avoid getting caught on any redemption snag, a little preparation goes a long way. Before you face the unexpected need to cash in fund shares quickly, learn how you would have to proceed and fill out whatever forms you might need. While you may not be able to avoid fees, you'll at least know what to expect.

One popular exit strategy is to arrange instant telephone-exchange privileges to your fund group's money-market fund, from which you can redeem shares by writing a check. Then the ability to redeem shares travels with you wherever you go, with a minimum of expense and hassle.

Chet Currier is a columnist for Bloomberg News.

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