The Best Places to Stash Your Cash

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.

Seeking stability
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

return, you’ll have money in case you need it right away.”

The next tier should hold money you don’t need right away. “One strategy is to build a CD ladder,” says Jordan. “You might put 25% of your money for this tier into a one-year CD. Put another 25% into another one-year CD that matures three months later, and so on, until 100% of your money in this tier

is invested in four staggered one-year CDs. You’ll have a CD maturing every three months, if you need the cash. If you don’t need the cash, you can roll it into another one-year CD.”

Of course, taking money from a certificate of deposit prematurely will incur a penalty. Typically, fines are equal to three months’ interest on short-term CDs and six months’ interest on CDs longer than 18 months. It pays to consider penalties as well as interest earnings before you purchase a CD, since penalty structures vary widely nationwide.

The third tier, says Jordan, might be for cash you don’t expect to need for a few years– you might be expecting to pay college bills, for example, or a down payment on a house.

Net gains
Another way to get some return on your cash is to open an online savings account. “I’ve used Emigrant Bank’s DollarSavingsDirect for myself and for my clients,” says Susan Moore, a financial planner in Watertown, Massachusetts. The current yield is 1.5%; according to SavingsAccounts.com, other online savings accounts offer yields from 1.10% to 1.60%.

Typically, brick-and-mortar banks allow you to electronically link your personal checking account to the online savings account. If that’s the case, it’ll take just a few mouse clicks to transfer money from your checking account to the online savings account (to get the higher interest), or from the online savings account to your checking account (when you need the cash). These accounts should come with no fees or service charges.

As you might expect, online savings accounts are federally insured, up to $250,000 per account, per bank. Although you generally have access to your money when you need it, it may take a day or two to transfer funds into your checking account, so be sure to plan ahead.

Betting on bonds
If you can part with your cash for more than a year or two, you may get even higher yields with a short-term bond fund. These funds hold bonds that are maturing in a few years.

Moore’s suggestions include Vanguard Short-Term Treasury Fund (VFISX) and Fidelity Short-Term Bond Fund (FSHBX). As the name suggests, the former invests primarily in securities issued by the U.S. Treasury. So, shareholders don’t have to

worry about bonds defaulting. In times of crisis, investors bid up the price of Treasuries

so this fund will probably do well (though if interest rates rise, bond funds typically lose value). The Vanguard Short-Term Treasury Fund’s current yield is around 1.6%; the interest is exempt from state and local income tax (but not federal) because the fund holds Treasury issues.

The Fidelity Short-Term Bond Fund has a higher yield, around 2.8%, because it invests in corporate bonds and mortgage-backed securities as well as Treasuries. (Non-Treasuries usually pay higher yields because repayment isn’t as certain.) This fund fell by around 12% from 2003 to 2008, with more than 7% of the losses occurring during the panic of 2008, when bonds other than Treasuries suffered heavily.

“Short-term bond funds aren’t risk  free,” Moore concedes, “but they’re low risk.” Indeed, the short-term bond fund track record is encouraging. In the past tumultuous decade, Morningstar’s short-term government bond fund category has yielded positive returns every year but two. The short-term bond fund category, including funds that hold nongovernment as well as government issues, has had only three losses–its most recent a 4.2% drop in 2008, when credit markets froze. Although past performance doesn’t guarantee future returns, it indicates that investors in short-term bond funds can probably collect a yield while they avoid steep losses.

This article originally appeared in the March 2010 issue of Black Enterprise magazine.