NEW YORK (CNN/Money) -
Short-term interest rates are slated to drop yet again Wednesday by a quarter or even a half point. That may be good for the ailing economy. But it might not be so great for the rate on your savings.
Still, dropping interest rates shouldn't stop you from saving. If you're caught without some cash, a costly emergency like a layoff or a hospital stay can make the low rates you've forsaken look like a gold mine. Planners usually say you should stash enough to cover 3 to 6 months' living expenses.
Savings vehicles come in every flavor: planners suggest a money market account, savings account, or money market mutual fund for emergency dollars, which have relatively low yields but high liquidity. If you have more than 6 months' cash, they recommend you expand into certificates of deposit (CDs) and ultra-short bond funds, which offer a better yield, though slightly less liquidity.
A mix of investment instruments, however, sometimes works best. Consider these:
Money market accounts These come in two varieties, money market bank accounts and money market mutual funds.
Today, the average money market bank deposit account pays 0.95 percent, according to Bankrate. The average money market mutual fund pays 1.21 percent, according to IMoneyNet. (Go figure -- 1.20 percent, a low hit the week ending Oct. 22 of this year, is the record low since 1975.)
|Product†||Internet Banks†||Banks & Thrifts†|
|Money Market bank accounts, $10K minimum†||1.90%†||1.13%†|
|3-month CD, $25K minimum†||1.82%†||1.48%†|
|6-month CD, $25K minimum†||1.99%†||1.58%†|
|Interest checking accounts, $10K minimum†||1.38%†||0.70%†|
|†Source:††Informa Research Services|
To find the best rates on money market accounts, click here.
Money market mutual funds invest in short-term securities, such as commercial paper or U.S. Treasuries, and try to keep their net asset value at $1 per share. The average term of all holdings in a money market fund is about 55 days, but assets cannot have terms longer than 90 days.
"A money market account with check-writing privileges lets you get the money quickly," said Scott Kahan, a certified financial planner in New York City. "It's a good short-term savings vehicle [to choose], with no volatility at all, and you have immediate access."
Mutual fund families offer money market mutual funds, which usually pay a bit more, but aren't insured by the Feds. (All bank deposits are FDIC insured, meaning the U.S. government has you covered up to $100,000 in case the bank fails. However, money market funds are widely considered as stable as money market bank accounts -- Vanguard isn't likely to shut down tomorrow and make off with your emergency fund.)
Kahan said money market mutual funds typically are the better bet, as the yields are a bit higher, the only caveat being that they're not FDIC insured. Sometimes, he added, it's good to keep a minimum in a money market deposit account at your bank, because that often rewards you with free checking services, and keep any other emergency funds beyond that minimum in a money market fund.
Bank savings accounts In today's weak interest rate environment, money market accounts and bank savings accounts will probably have about the same yields.
Phil Cook, a certified financial planner in Torrance, Calif., said savings accounts from virtual or online banks are a better deal than accounts from brick-and-mortar banks.
"Many virtual banks and credit unions offer liquid savings accounts paying around 2.75 percent," Cook said.
Short-term CDs Certificates of deposit get mixed reviews as repositories for emergency funds, chiefly because they are not as liquid as money market or savings accounts.
A CD guarantees an interest rate for a set period -- 3 months, 6 months and so on -- but you can't withdraw the money until the term is up. Cash out early, and you pay a penalty, typically a forfeiture of some or all the interest you've earned. How much you forfeit varies -- by institution and by the length of the CD's term, said Greg McBride, a financial analyst at Bankrate.
It's rarely a good idea to invest in a CD if you know you're going to cash out early. Typically, you won't be left with much of what you made in interest after you pay the penalty, McBride said.
However, CDs are a good place to keep "extra" emergency money -- if you've covered the bare minimum in a more liquid instrument, you can afford to get a bit of a return on any surplus.
A 3-month CD today pays 1.43 percent on average, according to Bankrate, and its 6-month cousin pays about 1.53 percent. Historically, however, rates for 3-month CDs have gone as high as 4.6 percent, in 2000.
Ultra-short bond funds These mutual funds keep your assets stable by investing in short-term, high-grade bonds. Turner Ultra Short Duration Fixed Income Fund, for example, with a current yield of 2.67 percent, invests in bonds issued by the United States government and high-grade, short-term mortgage securities.
Like CDs, ultra-short funds work well for secondary emergency savings. And their rates tend to fluctuate less than the rates on other assets when the Fed adjusts short-term interest rates, making them an even more attractive savings vehicle if the Fed cuts rates again Wednesday.
Withdrawing from an ultra-short fund is like withdrawing from any mutual fund, said Melanie Woloz, a certified financial planner in Los Angeles. You would request the amount and get the money sent to you within two weeks.
"I'd start with a money market account, but once you have the basic 3 to 6 months saved up, the extra could go in a secondary emergency fund, an ultra-short fund. "They're stable, and you can get a little bit of return on your money."