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Squeezing More Pennies from a Cache of Cash
By Robert d. Hershey Jr., the New York Times
October 10, 2004
You’ve been letting your cash reserves pile up but are frustrated by the almost insultingly skimpy returns - in many cases, well under 1 percent - that they are producing. A fine reward, you may be thinking, for your thrift when so many feckless Americans are in debt.
But try to look at the bright side. The Federal Reserve has embarked on a path to raise short-term interest rates, which had sunk to their lowest levels in 45 years. Its latest move came on Sept. 21, when it raised the target for its overnight benchmark to 1.75 percent from 1.50 percent.
Yet savers do not have to rely solely on the government to get more for their money, whether it be a stash for emergencies, sidelined stock-market money, an uninvested windfall or just an ordinary household account.
There are many things you can do to enhance returns, with little or no additional risk.
Money market mutual funds, where nearly $2 trillion of this money already resides, will pay higher rates, of course, as the Fed tightens credit. Despite the usual lag as their portfolios mature and are replaced with higher-yielding securities, most money market funds in mid-August regained the rate advantage they have traditionally held over money-market deposit accounts at banks. At the end of the third quarter, the funds' rates averaged 1.09 percent for the latest 12 months, versus 0.92 percent for the banks' money market accounts.
By year-end, according to Peter Crane, a vice president of iMoneyNet in Westborough, Mass., money fund rates should be pushing 1.5 percent. Still, that would be only a little more than half of the consumer inflation rate.
Because interest rates are so low, it is especially important to keep money fund fees to a minimum. "Strategy No. 1 is to move to a low-expense money market fund," said Bruce J. Berno, an independent financial planner in Cincinnati.
He pointed to the Vanguard Prime Money Market fund, which costs 0.32 percent a year, less than the industry average of 0.56 percent. The fund had a yield of 1.41 percent at the end of the third quarter, above the industry average.
Fees can be especially important at a time when some funds charge almost as much or more in expenses than they are providing in yield. At the end of the third quarter, AllianceBernstein Capital Reserves was charging 0.97 percent in annual fees, and its yield was 0.66 percent.
And if you have multiple accounts, it is probably a good idea to consolidate them to get the higher rates that larger balances often command.
Investors may also get some help on expenses from the Securities and Exchange Commission. Some S.E.C. officials have expressed worries that some money market fees are excessive.
Experts also recommend another look at money you may have parked in brokerage house money funds that are typically used as repositories for periodic sweeps of dividends and other account income. Many brokers have set up banks for this purpose, but whether or not such banks are used, the funds' yields are often substantially less than those of ordinary money market funds.
If you keep a lot of money in a brokerage-house fund, it never hurts to ask for a bit more yield, or, if you're depositing fresh cash, to ask that it start earning interest faster. It is not unusual for a fund to make you wait five business days before it starts to credit interest, but an investor with a substantial or active account may be able to win a reduction to, say, three days.
Alternatively, consider tax-exempt money funds. Because tax-free rates did not decline as much as others during the interest-rate swoon, returns on these funds are currently nearly as high - and in a few cases, higher - than those for taxable funds. Tax-exempt funds for your own state, offering an additional exemption, can be even more appealing.
Then there is a highly attractive investment that offers substantially more yield but is widely misunderstood or overlooked, partly because of terminology. This is the category of stable value funds, which are sometimes known as guaranteed interest income funds, as capital preservation funds or even as fixed-income funds.
Stable value funds, devised primarily for employer-sponsored 401(k) retirement accounts, have portfolios of high-quality, short-maturity bonds "wrapped" with insurance contracts that protect against swings in interest rates. Some $350 billion is already invested in them, but many plan participants who have this option may not know it because of the funds' varying names.
With returns averaging more than 4 percent - and with risk that is only slightly higher than for money funds - stable value funds "have been the life raft for retirement savers through the rocky times of the last four years," said Gina Mitchell, president of the Stable Value Investment Association, a trade group in Washington.
Because of that record, specialists advise workers to look closely at their 401(k) plans and to take advantage of any stable value option.
"We strongly recommend stable value funds," agreed Mr. Berno, adding that this was a particularly good time to switch assets into them from longer-term bond funds, which lose substantially more value than short-dated investments as interest rates march higher.
Reflecting this strong appeal, eight stable value mutual funds have sprung up outside 401(k) plans and have accumulated some $6.6 billion through individual retirement accounts. But their future is clouded by questions the S.E.C. has raised about the proper valuation of the insurance wrap in funds that are not part of 401(k)'s.
One stable value fund, the $60 million Principal Investors Capital Preservation, was converted to a money market fund on July 29, and some other sponsors have converted their stable value funds to bond funds. "They're potentially taking away a great investment for individuals" outside 401(k) plans, a high-yielding, secure and diversifying instrument for which there is no good substitute, Ms. Mitchell contended.
Another way to juice up returns on cash reserves is through ultrashort bond funds. The bonds in their portfolios come due very soon - typically in one to three years - which means that your capital can then be reinvested at new, perhaps higher rates.
Judith Lau, a principal at LauOlmstead, a financial planner in Wilmington, Del., said that her firm was putting clients into such funds. "We find we can do this with only a small differential in the risk level," she said.
She pointed to Schwab YieldPlus-Select, which has an expense ratio of 0.41 percent and an average maturity of 2.7 years. At the end of the third quarter, it yielded 2.6 percent, according to Morningstar Inc.
Fluctuations in net asset value have been 5 cents or less for the past two or three years, noted Jacob Weaver, a LauOlmstead investment manager. "We like the stability," he said.
But be aware that some bond funds, though not Schwab YieldPlus-Select, levy redemption fees to discourage short-term trading. That could disrupt portfolio management, specialists warned.
Other alternatives include depositing money in credit unions or Internet banks, which may pay higher rates than brick-and-mortar banks. Funds investing in variable-rate loans and even a tax-deferred fixed annuity may also be appropriate, they said.
AND if you like the higher returns of longer-term bank certificates of deposit, but don't want to give up much liquidity, you can gradually build a "ladder" of C.D.'s - arranging for them to come due in regular progression, then reinvesting them for the same long terms. The ladder, for example, might have 10 five-year C.D.'s, maturing six months apart. Some five-year C.D.'s now pay more than 4 percent a year.
To make C.D.'s more attractive, banks have been introducing varieties that give investors at least some of the benefit of rising rates. Called bump-up, step-up, opt-up or index-linked C.D.'s, they allow an investor, in effect, to refinance for a higher yield at least once before the maturity date. But Mr. Crane cautioned that a C.D. paying 2.5 percent "may look attractive now, but six months from now money funds might be outyielding it."
Whatever you do, make sure that it fits your circumstances. "If you want to pay college tuition next January," Mr. Berno said, "you don't want to buy a 12-month C.D."
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