Issue Date: October 28, 2001
Investing's wild ride
Buying stocks these days could make anyone queasy.
To protect short-term assets, deploy these strategies.
PUTTING MONEY into the roller coaster of a stock market we've been experiencing lately is fine - even advisable - if you have at least five years to ride out the bumps. Chances are, though, you'll need some dollars sooner: to pay a college tuition bill in 2003, or to make the down payment on a house in 2004.
That money doesn't belong in stocks. Instead, you want to park it where it can earn a higher return than the meager 1% to 2% you'd get from a savings account. Admittedly, that's more difficult to do at a time when the Federal Reserve is slashing short-term interest rates. But you do have some choices (all rates quoted are as of early November):
Money market mutual funds
Current average yield: 2.7% (securities)
The lowdown: Money market funds are an investment concept that has been around for 30 years. Today, these funds don't yield much - which is not to say you shouldn't put some of your cash in one. "The mantra of money funds has always been safety, liquidity and yield, in that order," says Pete Crane, managing editor of the fund tracker iMoneyNet.com. To find one that's above average, look at funds that keep a lid on expenses.
Surprisingly, Crane advises steering clear of the very best performing funds; instead, pick one that's in the top half of its class. Why? "You should just assume that top performer is taking just a little extra risk to get there," he says. "When we've seen problems with ultra-short-term bond funds and money funds in the past, it's almost always the No. 1 performer that goes from hero to zero." Another factor to weigh: convenience. If you're eventually going to use that cash to buy a Vanguard index fund, for example, then it makes sense to put it in a Vanguard money fund.
Consider: Vanguard Prime MMF, 1-800-662-7447; Fidelity Cash Reserves, 1-800-343-3548.
Certificates of deposit
Current average yield: 1-year CD, 2.95%
The lowdown: When rates are falling, certificates of deposit offer the benefit of allowing you to lock in a rate before Fed Chairman Alan Greenspan makes his next move. What you lose, however, is liquidity. And, in an uncertain economic environment, where layoffs are in the news every day, that may not be a wise move. That's why Crane doesn't recommend CDs for the core of your nest egg. Still, he says, "diversifying is always a virtue." Note: The best CDs almost always offer a significant premium over the average ones. You can find them at bankrate.com.
Consider: Netbank, 1-year CD, 3.69%, 1-888-256-6932; ING Direct, 1-year CD, 3.5%, 1-800-464-3473.
The Series I Savings Bonds (I Bonds)
Current yield: 4.4%
The lowdown: Although there is no reason to believe we'll see inflation in the next few months, it's quite possible the Fed's interest rate cuts could spark an economic revival, and under that scenario, inflation is a threat. I Bonds, which are savings bonds indexed to keep pace with inflation, protect investors from that. These bonds also are exempt from state and local income taxes (and you can defer the federal taxes for as long as 30 years). They're fairly liquid, too: You can cash them in after six months. Eric Jacobson of Morningstar says that although I Bonds "don't appear to be a screaming buy right now, they're an almost essential portfolio diversifier for almost any long-term investor."
Consider: You can buy them direct on the Web at www.publicdebt.treas.gov/td/tdintro.htm; click on "For I Bond Investors."
Short-term bond funds
Current average yield: 7.95% year to date
The lowdown: The numbers we have been seeing from short-term bond funds are more akin to those we've come to expect (or hope for) from stocks than from so-called safe investments. At these levels, they're probably not sustainable. If the Fed successfully sparks economic growth, "the bond market may tread water for a while, even turning in anemic or slightly negative returns," Jacobson says. For now, though (and he believes it could take two to three years for that scenario to unfold), putting a portion of your cash in a high-quality short-term fund is going to be tough to beat.
Consider: Vanguard Short Term Federal, 9.21% YTD, $3,000 minimum, 1-800-871-3879; Metropolitan West Low Duration, 7.71% YTD, $5,000 minimum, 1-800-241-4671; Montgomery Short Duration Government, 8.48% YTD, $1,000 minimum (rate available online only at www.montgomeryfunds.com).
Contributing Editor Jean Sherman Chatzky is the author of Talking Money (Warner Books, $24.95). Additional reporting by Marcia Meyers.
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