LINDA STERN

When safety, accessibility are key, money markets still a lock

Email|Print|Single Page| Text size – + By Linda Stern

September 15, 2007

Cash is not trash, it's the basis for a successful financial life.

Having some money stowed away for a rainy day will keep the tax bill, unexpected illness, or a broken appliance from stealing your peace of mind. Having an additional amount put away for a future stock market purchase is even better.

The question is: Where do you keep it?

Many folks keep their short-term "cash" in money market mutual funds. But recent reports that some bad mortgage debt might have found its way into money funds have scared off some people.

Not me. I remain convinced money market funds run by big name investment companies still offer the best combination of yield and security for parking money. These funds invest in short-term Treasury bills, certificates of deposit, and corporate loans, and keep their share prices at $1. They offer liquidity, interest at market rates, and as much safety as you can get without a government guarantee.

To be clear, it's not total safety. Bad debts within a money fund could cause it to "break the buck" (drop its $1 a share price). It happened once - to a tiny Denver-based fund in 1994, when the price dropped to 96 cents a share.

That's not likely now. Most issuers would support their own money funds, even if they had to add cash to keep that share price at $1, says Peter Crane, of Crane Data, a Westborough, Mass., research firm. And the amount of problematic loans within money market funds seems small, compared to the $2.77 trillion in assets they hold.

Not everyone will want to keep all their cash in a money fund. Other options might be more suitable for different purposes. Here are some pointers for choosing a fund and for finding alternatives.

"There is safety in numbers and deep pockets," says Crane. He means that behemoth issuers - the household names in mutual funds and brokerages - will not let their money funds break the buck. Also, funds that have middling yields (just under 5 percent, now) are probably investing more safely. The outliers - those small money funds eking out 7 percent in today's market - are taking bigger risks to get there and should be avoided, he said.

If you absolutely have to have the government guarantee, use a bank money market account. They are FDIC insured but tend to pay lower rates, averaging around 3.6 percent now, according to bankrate.com.

"Yields on money market funds are nearly 4 percentage points higher than yields on bank deposits. This is the largest money fund yield premium since June 2000," reports the Investment Company Institute. You can get higher rates by using online banks or new banks competing for your cash. Just don't put so much in your money market account that you're over the $100,000 FDIC limit.

Revisit CDs. Cash-starved Countrywide is paying 5.65 percent for a one-year certificate of deposit right now, and that is FDIC insured. Other banks are offering lower interest rates, but in some cases they compare favorably with money market funds. Not all "cash" needs to be liquid at all times. You could split your emergency fund into smaller amounts and buy CDs that matured at different times. Over time, that would maximize earnings but still insure you had some money coming due at all times.

Beware of short-term bond funds and ultra short-term bond funds. Long peddled as an alternative to money market funds, they showed their greater risk potential in recent weeks, losing money for their investors. "They make lousy money market substitutes," concludes Morningstar's Russel Kinnel. Diversified investors might like to keep some money in short-term bond funds over the long haul, to squeeze out some extra return. But they aren't cash equivalents.

Don't lose your perspective. The purpose of "cash" accounts is to keep your money safe and accessible. Squeezing out extra returns is nice, but not worth taking big risks. If you have $10,000 in your cash account, the difference between earning 4.9 percent and 5.2 percent for a year would be $25 a month. That's not much to give up for sound sleep at night.

Linda Stern is a freelance writer. She can be reached at lindastern@aol.com.

When safety, accessibility are key, money markets still a lock

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