A whopping .04% return on savings

Yields on money market accounts and CDs are pretty low right now, but that doesn't mean you should go chasing higher returns.

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By Walter Updegrave, Money Magazine senior editor

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Walter Updegrave is a senior editor with Money Magazine and is the author of "How to Retire Rich in a Totally Changed World: Why You're Not in Kansas Anymore" (Three Rivers Press 2005)
What you need to save

NEW YORK (Money) -- Question: My wife and I keep $20,000 in a passbook savings account as an emergency reserve. What's driving me crazy is that we're getting only 60 cents a month in interest. I like the security of the account and the immediate access, but 60 cents a month on 20 grand???? How can I do better? --Dale F., Waldorf, Maryland

Answer: Assuming you're really only earning 60 cents a month in interest, your bank is paying you a grand annual yield of 0.04% -- that's right, four hundredths of a percent.

That's miserly even considering today's rock-bottom interest rates. So I don't think there's any doubt that you can do better. You can, easily.

If you go to the Checking & Savings section of Bankrate.com, for example, you'll see that bank money-market accounts are yielding just a tad over 1% these days on average. And by doing a quick search on the site, you can find banks that are paying upwards of 1.8%. You may be able to do even better by opening an account with $10,000 or more.

Of course, these rates aren't locked in. Banks change them depending on credit-market conditions and what they believe they have to pay to attract the deposits they need.

You could lock in a rate by putting some of your savings into a CD. But you want to be careful. For one thing, today's rates aren't so attractive that you want to lock them in for long. More important, if this money is serving as an emergency fund, you want it to be readily accessible. That suggests sticking to short-term CDs, or those with terms of, say, six months to a year, which have been yielding 1.4% and 1.7% respectively, although again you shouldn't have trouble finding CDs that pay more than the average.

But while moving your money to a money-market account, short-term CD or a combination of the two might boost your monthly take from 60 cents to as much as $30 a month -- a huge percentage increase, to be sure -- it's not as if 1% to 2% a year is a knock-your-socks-off rate.

Which is why many people in your position are often tempted to stretch for additional yield. I have one word of advice to offer in case you're inclined to follow their lead: Don't.

With interest rates scraping the floor the past couple of years, people have turned to everything from annuities to non-bank CDs to auction-rate preferred securities to bank-loan funds in pursuit of loftier payouts on their cash reserves. The reason is that these and other vehicles appear to offer a tantalizing combination of high income and security.

But there's always a hitch or latent risk. Annuity buyers may find themselves whacked by high surrender charges when they tap their account. People who purchased auction-rate securities suddenly saw the market for those securities dry up last year, leaving them holding investments that were suddenly worth far less than they thought, and difficult to unload to boot. As for bank loan funds, yes, they've rebounded this year, but the 30% average loss such funds suffered in 2008 shows they don't offer real stability.

Even ultra-short bond funds, which are supposed to provide higher yields than money-market funds while maintaining comparable stability, have shown that they can stumble badly, witness last year's average loss of almost 8% for the category.

When it comes to the money you need for ready cash and emergencies, you want to stick to true cash equivalents -- i.e., bank money-market accounts or short-term CDs that qualify for FDIC deposit insurance or high-quality money-market funds at large financial institutions. (At the moment, money-market fund yields trail those of bank money-market accounts, but I would expect that to change as the economic recovery gains traction and interest rates start to creep up.)

Which means that, for now at least, you'll have to accept some pretty underwhelming yields (although not as underwhelming as 0.04% a year) for your reserves. But remember, your primary goal with this portion of your savings isn't to maximize return; it's to assure a high level of security and stability.

If you find little solace in that notion, then think of it this way: what you give up in potential return, you will gain in peace of mind by knowing that you'll have the funds to deal with an emergency or other cash need should it arrive. To top of page

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