Where to Stash Your Cash

With short-term rates heading up, money-market accounts, savings accounts, and money-market funds offer safety and better returns than your mattress

Here's a hot tip to share with friends at summer barbecues: a 5% money-market fund. It's not sexy, but with stocks struggling, savings accounts and other short-term instruments with yields approaching 5% look mighty nice.

Thanks to the Federal Reserve, cash holdings are attractive again. Since June 2004, the Federal Open Market Committee (FOMC) has gradually raised the fed funds rate (what banks charge each other for overnight loans) from 1% to 5%, causing rates on money funds to edge up also. Considering the recent tough talk on inflation by Fed members, interest rates could head even higher (see BusinessWeek.com, 6/14/06, "The Fed: Trapped by Rhetoric?"). Worries that this will choke economic growth have sent stocks into a tailspin in recent weeks, causing some investors to retreat into cash and other safer holdings.


  Whether you own liquid assets in anticipation of better investing opportunities ahead or simply as a "rainy day" fund, banks and fund companies have safe places to stash your cash. At banks, the basic high-yield choices are money-market accounts and savings accounts, while fund companies offer money-market funds.

When picking a short-term cash repository, experts say you should consider both yield and convenience. It's fairly easy to determine the current yield champs. Online services post rankings of the top-yielding bank money-market accounts and savings accounts (Bankrate.com) and money-market funds (iMoneyNet.com) each week. At the top of the rankings, banks and funds generally offer comparable yields. "They are neck and neck with each other," says Greg McBride, senior financial analyst at Bankrate.com.

Here's a guide for picking the right one for you:

Read the fine print for fees.

While most money-market accounts and savings accounts have no minimum balance requirements, some impose monthly fees on small accounts. That can significantly reduce your actual yield. If you pick an account that imposes a fee, be sure that you will be able to maintain the minimum balance needed to avoid having your returns clipped.

Check returns.

In the money-market fund world, notes Connie Bugbee, managing editor at iMoneyNet, your initial screen should be for current high yield. But, she says, it pays to check the fund's 3-, 6-, and 12-month returns to be certain that today's high yield isn't a fluke. To find those returns, call the fund's toll-free number.

Consider taxes.

The key to a good money-market choice is not how much you make, but how much you keep. "Typically, it does pay for investors in higher tax brackets to look at tax-exempt money-market funds," says Scott Berry, mutual fund analyst at Morningstar (MORN). These funds buy short-term municipal debt and offer lower nominal yields than traditional money-market portfolios.

To determine if a tax-exempt money fund is right for you, divide its yield by 1-minus-your-tax-bracket. For example, if a municipal money fund yields 3.1% and you're in the 28% federal tax bracket, a taxable money fund would have to yield 4.31% (3.1/.72) to provide the same after-tax return. If you live in a high-tax state, many companies offer single-state municipal money funds that can be attractive.

Here's the rub: The alternative minimum tax (AMT) can upset the neat calculation that determines your choice between taxable and tax-exempt money funds. If you're subject to the AMT, income from certain types of municipal debt is taxable. Before buying a tax-exempt money fund, contact the fund to determine how much of last year's return was exposed to the AMT.

A fund's name can give you a leg up in your search. If the fund uses "muni" in its name, 20% or more of its holdings can be in paper subject to the AMT, says iMoneyNet's Bugbee. A fund calling itself "tax-free" will have less than 20% of its assets in AMT paper, she says.

Decide how you plan to use the cash.

If you're holding cash in anticipation of a buying opportunity in stocks or mutual funds, a money-market fund linked to your brokerage or fund account is a good choice. When you believe the time is right to buy, one phone call will handle the transaction. A slightly higher yield available from a fund company might not be worth the hassle if most of your other investments are with a different one.

Understand how to get access to your cash.

Most savings accounts don't offer checking, while most money-market accounts do. Even so, money-market accounts limit the number of checks (usually six) that you can write each month. Some accounts offer links to your regular checking account, so that you can transfer money with the click of a mouse. Others give you ATM access. Avoid accounts that you can only add to, or withdraw from, by mail.

Check writing is a fairly standard feature of money-market funds, which usually come with no limit (or a fairly high limit) on the number of monthly drafts you can write. But money funds often require a minimum initial investment and a minimum dollar amount for each check written. So you can't use your money fund to pay for a few items at the supermarket.

Shop for the best yields online.

Although you may find an attractive rate on a high-yield money-market account or savings account offered online by your local bank, don't expect to walk into a branch and get the same deal. Most of the highest yields are offered only via the Internet.

Bankrate.com's McBride draws an analogy to the travel industry: "When I buy an airline ticket, I can do it several ways, but it's cheaper for the airline if I buy it online," he says. At online banks, those savings are passed along to account holders in the form of higher yields. Similarly, money-market mutual funds with the lowest expense ratios tend to have the highest yields.

Is it safe?

Make sure your money-market account or savings account is FDIC-insured. That way, Uncle Sam has your back. However, as investment companies, money-market mutual funds have no government insurance. Theoretically, they could suffer losses. But money-market funds are highly regulated, and invest in instruments that will mature shortly, so losses are unlikely. "They're about as safe as you can get," says Morningstar's Berry.

If you're worried about losses, pick a fund that invests only in debt issued by the U.S. Treasury and government agencies. "No retail money fund has ever failed," says iMoneyNet's Bugbee, "but there is an element of the population that feels safer (in a government fund)." Buy a government money fund, she advises, "only if it brings you peace of mind."

As of June 13, here are the top-yielding savings accounts and money-market accounts according to Bankrate.com, and money-market funds according to iMoneyNet.com.

  Savings Accounts
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