Financial advisers constantly recommend this basic principle of fiscal management: Maintain an emergency cash fund of between three and six (or more) months of living expenses. But what’s the safest way to store the money, keep it at your disposal, and still earn some interest on it?
There’s no easy answer these days. Money market funds have traditionally been great parking places for cash. Few investors have lost money there, and you have easy access to your funds when you need them. When interest rates rise in inflationary times, money funds pay higher yields. But in the current economy, the Federal Reserve has kept interest rates low to spark a recovery. As a result, yields on money market funds are scant. According to iMoneyNet.com, the average money market fund yields only 0.03% ($3 in interest per year on a $10,000 investment); the highest 12-month yield is 1.06%.
“Maintaining interest rates at record lows for an extended period is still central to the Federal Reserve’s economic game plan,” says Greg McBride, senior financial analyst at Bankrate.com. “The Fed doesn’t want to throw cold water on financial markets by raising interest rates.” Therefore, money market fund rates will most likely remain stunted for a while.
The possibility of collecting a meaningful yield while avoiding steep losses appeals to Linda Brown, 61, a psychology professor in Buffalo, New York. She invested heavily in cash after the stock market crashed in late 2008. “In 2009,” she says, “I kept losing money. The return on my money market fund was so low that I was paying more in fees.”
Since then, Brown has returned to a balanced portfolio but she is still leery of stock market volatility. “All my new contributions to the New York State Deferred Compensation Plan are going into the Stable Income Fund,” she says. This fund holds mainly various short- and intermediate-term bonds, often backed by insurance company guarantees. It now yields 3% to 4%. “I’m happy with that return, in today’s market,” says Brown.
This Stable Income Fund is a type offered as an option in many employer-sponsored retirement plans, and they’re also available for IRAs. “Short-term bond funds may be a good place for cash,” says Deborah A. Jordan, a financial adviser with Ameriprise Financial in Eden, New York.
Layers and ladders
Jordan advises her clients, one of whom is Linda Brown, to think of cash in terms of tiers. “Start with holding at least three months of spending money in a money market fund or a checking account,” she suggests. “Even if you’re not getting much of a