Independence Day is here and as we celebrate America’s birthday with fireworks and summer BBQs, let’s pause to remember that America is truly the land of opportunity. America is where anyone can achieve their dreams—including the pursuit of financial independence!

Obviously, the first step towards achieving financial independence is keeping a pot of cash handy. Having at least a portion of your assets in cash is simply a prudent and useful money management tool. In fact, I think of my cash holdings as a shock absorber for the rest of my portfolio.

To preserve your cash, money market funds offer a high-yield alternative to bank savings and checking accounts. And when it comes to money market funds, “better” means “cheaper.” That’s why you always win the cash game at Vanguard (I’ll give you some specific names in a minute). Vanguard’s money funds are so low-cost and so safe that it’s a no-brainer when it comes to deciding where to stash your cash. Here’s why every investor should own them:

1. You can gain by not losing.

Money market funds are safe, safe, safe. They simply don’t lose money.

When it comes to deciding where to stash your cash, Vanguard’s money funds are so low-cost and so safe that it’s a no-brainer

2. You can pay your bills.

Check-writing privileges on money market funds make them incredibly convenient. And writing a check on a money market fund doesn’t create a taxable transaction that must be reported to the IRS, unlike a check written on a bond fund.

3. You can stay with a plan.

Money market funds are useful if you follow a dollar-cost averaging, value-averaging or other systematic investment plan. Your money continues to earn interest, and remains completely safe. If you have Vanguard mutual funds, you can move with ease with a single phone call or a visit to Vanguard’s website.

4. You can shift your allocations.

For instance, if you have stock and bond funds, and want to gradually build up cash reserves, just instruct Vanguard to automatically deposit all dividend and capital gains distributions from your stock and bond funds directly into a money fund, rather than reinvesting them.

This can make your life easier at tax time since you won’t have all those odd, reinvestment transactions to account for. And it will help you slowly build the cash position in your portfolio.

Oh yes. And there’s one more thing …

5. You can be ready for a rainy day.

Remember: Cash is a good rainy-day asset. When the stock or bond markets take their hits and you believe that the market pendulum has swung too far to the bearish side, cash gives you buying power. Meantime, while you wait, the money market fund is paying you interest, which currently is a pretty nice number.

Your money fund is a high-yield alternative to bank savings and checking accounts. That’s just smart cash management.

Taxable or Not?

I hope you can see why a good money market fund is essential to building and maintaining your wealth. Now let’s talk about specifics.

With 10 Vanguard money funds to choose from the question remains: Which one to buy?

Money markets are no different from bond funds in one respect: No matter how little money you actually stash there, it’s worth taking the time to decide if a tax-exempt fund’s tax-free yield is a better alternative than the higher yields on Vanguard’s taxable funds.

In most cases you’ll opt for the tax-exempt fund (unless of course you’re holding cash in a tax-deferred account like an IRA).

It’s actually been a pretty confusing period for money fund shareholders these past couple of years as the yield “spread” between taxable and tax-exempt money funds has fluctuated widely. For more than half of 2004 and briefly in 2005, the yield on Tax-Exempt Money Market, for instance, was actually higher than that on Prime Money Market (traditionally Vanguard’s highest yielder). Since early 2007, the spread between the yield nonprime Money Market and Tax-Exempt Money Market has narrowed, making the tax-exempt fund relatively more attractive to more investors.

Unless you’re in the 15% or 25% income tax brackets, it’s a good bet that tax-exempt money funds will generate a higher return for you.

One place where investors can often miss the point of tax-free investing is in Admiral Treasury Money Market, where assets stand at almost $18 billion.

I’m afraid some Admiral investors with taxable accounts are blindly buying this money fund because of its low expenses and premium entry fee. (Their thinking being, “If it’s hard to get into, it must be good.”) Chances are good that Tax-Exempt Money Market or one of the state tax-exempt money funds makes better financial sense.

Of course, for some investors, the added value of the U.S. Treasury’s full faith and credit may allow them to sleep better at night even if the yield doesn’t match Prime’s. At that point, the extra yield isn’t worth insomnia.

By the way, I list tax-equivalent yields for all of the tax-free funds in every issue of The Independent Adviser for Vanguard Investors. Click here for more information.

For me, the high credit quality of all of Vanguard’s money market funds and the research skills employed by Vanguard’s money market team give me enough confidence to predict that none of Vanguard’s money funds is going to “break the buck.”

So, owning Treasury’s only for their greater safety seems silly. I would just keep my eye on the yields.

Every Thursday The Wall Street Journal publishes a list of taxable and tax-exempt money fund yields. Check it out. Every time I scan the list, I look for any money funds yielding more than Vanguard’s yields. It’s pretty tough to find any competition.

And when I see the horrible yields offered by some of the largest money funds run by banks, I can’t believe investors allow themselves to be scalped like that.

So if you’re paying too much money to the bank… stop it!

Remember, money markets are not investments.

Despite the fact that there will be periods where money funds outperform stock funds, they have traditionally been unable to outpace inflation. So, at times, money funds can look smart, but don’t think of cash as a return booster, think of it as a volatility buffer.

As long as our objective is to have some safe, liquid money available, then cash (and Vanguard’s money funds, in particular) is the ultimate money-holding vehicle and one of the three important legs on your portfolio stool.

Money market funds are not “investments” per se, but I believe they deserve a place in every investor’s portfolio.