Create a CD ladder
For sums above $25,000, certificates of deposit still offer the best combination of safety and yield. CD rates keep "slip-sliding away," says Greg McBride, of Bankrate.com. So shopping around is more important than ever. Yields from the top-paying banks range from 1.8% to 3.5%, depending on maturity.A bank that offers a high yield in one maturity typically offers the best rates in other maturities as well. State Bank of India, in New York, which is the U.S. operation of India's largest bank and a member of the FDIC, is among the top yielders in five of the six maturities from six months to five years. Ally Bank, formerly known as GMAC Bank, and Discover Bank are among the institutions offering the best rates in all six categories -- although neither offers the highest rate in any maturity.
A good way to invest in a CD portfolio is to create a ladder of CDs with maturities that range from six months up to five years. That way you can take advantage of higher rates when you reinvest your shorter-maturity CDs, while still earning higher yields on longer-term CDs. CD rates are likely to rise when the Federal Reserve raises short-term interest rates, but that probably won't happen until a year from now, if then.
As of Jan. 1, 2014, deposit-insurance limits revert from $250,000 to $100,000 per depositor per bank or credit union. If you have more than $100,000 to invest in CDs that mature after 2013, divide your cash among several institutions.
More risk, more reward
No uninsured financial instrument is bulletproof. But that doesn't mean you should rule out all funds that invest in short-term bonds and bank loans. Yes, a few short-term bond funds lost more than 20% last year during the credit crisis. But for the most part, the types of funds designed to yield a few percentage points more than certificates of deposit and money-market funds without great swings in net asset value (or NAV, a fund's share price) have kept up their dividends. And as credit conditions improve, NAVs are recovering.More from MSN Money and Kiplinger
Low fees, no games: A good place to start is Vanguard Short-Term Investment Grade (VFSTX). Vanguard bond funds rarely play games -- what you see is what you get -- and they benefit from low fees, which are particularly important in a low-interest-rate world. This fund's annual expense ratio is just 0.21%. Despite investing in bonds with an average credit quality of single-A and an average maturity of less than three years, the fund lost 4.7% last year -- disappointing but tolerable considering the damage many other short-term bond funds sustained. Vanguard Short-Term has recovered nicely in 2009, gaining 12.2% through Sept. 22. The fund sports a current yield of 2.8%.
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Backed by the government: Technically, you can't call Ginnie Mae funds cash substitutes, but they play the part as if they were born to it. Ginnie Mae funds own packages of home mortgages, not short-term debt, but the funds kept their value through the financial crisis. That shouldn't come as a surprise because Ginnie Maes are backed by the full faith and credit of the U.S. government, making them much sounder than other mortgage-related investments. Vanguard GNMA (VFIIX) has a much lower duration (a measure of interest-rate sensitivity) than GNMA indexes or other funds, so rising mortgage rates shouldn't hurt much. Vanguard GNMA returned 7.2% in 2008 and has gained 4.5% so far this year; it yields 3.8%. In addition to Vanguard, Fidelity, Payden, Pimco and T. Rowe Price all have fine GNMA funds.
For a little more risk: If you're willing to take on more risk, consider a bank-loan fund. Fidelity Floating Rate High Income (FFRHX), with a current yield of 4.4%, is once again an attractive place to store some cash now that we've seen the worst of the recession. The fund, which invests in loans made by banks to companies with below-average credit ratings, lost 16.5% last year because of the credit crunch. But it's rebounded with a vengeance this year, gaining 25.9%. Monthly cash payments are half what they were a year ago because the interest rates on those bank loans reset periodically and have trended down along with other short-term rates. When the Federal Reserve starts raising short-term rates, Fidelity Floating Rate will make bigger distributions.
Tax-free funds: Among tax-free funds, consider Alpine Ultra Short Tax Optimized (ATOIX), which owns tax-exempt securities close to maturity. It actually made money last year, producing a total return of 3.6%, and it's gained 2.9% so far this year. Manager Steve Shachat says one way he guards against losses is by refusing to buy sharply discounted bonds in hopes of capturing a capital gain. At last report, Tax Optimized had more than 70% of its assets in variable-rate demand notes -- long-term debt securities with floating interest rates. The fund yields 2.7%, which is equivalent to 4.2% from a taxable investment for someone in the 35% federal tax bracket.
Another standout in the tax-free arena is Fidelity Intermediate Municipal Income (FLTMX), a member of the Kiplinger 25. As the name indicates, the fund invests in medium-maturity bonds (as of Sept. 22, its average duration was 5.2 years, suggesting that the fund's NAV would drop 5.2% if interest rates were to rise one percentage point). But rates aren't likely to be heading up anytime soon, and the fund, under manager Mark Sommer, has been a steady performer. It eked out a 1% return last year and so far this year has gained a solid 8.7%. The fund yields 2.8% tax-free, equivalent to a taxable 4.3% for an investor in the 35% federal bracket.
This article was reported by Joan Goldwasser and Jeffrey R. Kosnett for Kiplinger's Personal Finance Magazine.
Published Nov. 5, 2009
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