(Money Magazine) -- When you think of the words "safe income," a savings account probably doesn't spring to mind.
Sure, such accounts are safe as can be, as long as the banks you choose are covered by the Federal Deposit Insurance Corp. and your deposit in each is below $250,000. It's the "income" part that's the problem. They pay such piddling interest that you're better off in a short-term bond fund, right?
Not necessarily. True, the average bank savings account currently pays 0.22%, vs. 0.42% for the average one-year Treasury and 1.89% for the average taxable short-term bond fund. (Taxable money-market funds pay literally next to nothing: 0.03%.) But consider these facts:
Short-term bond funds are riskier than they used to be.
With rates so low, some fund managers are trying to juice yields by holding bonds with poorer credit quality, longer durations, or both. That, plus rising rates, means you could lose money. And remember, plenty of short-term bond funds fell by double digits back in 2008.
Solid banks have cranked up rates to attract depositors.
"There's a pretty wide disparity between the average rate and the rate you can get from banks that are aggressive," says Richard Barrington of MoneyRates.com.
For example, SmartyPig, an online savings service affiliated with West Bank of Des Moines, is offering 2.15% on balances below $50,000. Caveats: If your balance is higher, the rate falls to 0.5%, and you must agree to make contributions until you hit a savings goal you choose.
The most generous bank accounts with no such restrictions pay in the 1.29% to 1.35% range. That's only about 60 basis points less than the typical short-term bond fund. Make sure any bank you choose is FDIC-insured (go to fdic.gov to check) and has a safety rating of three stars or more at Bankrate.com.
The bottom line: If a slight yield edge is more important to you than guaranteed safety, stick with a short-term bond fund. Otherwise, go for a high-interest savings account (or accounts), being sure to keep your balance under $250,000 in each institution. You'll benefit once rates start to rise -- and have the freedom to move your money if other things start looking more mouthwatering.
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