Financial Makeover: Income Alternatives

April 29 -- Gary wants to place some of his $140,000 currently invested in a money market fund into a conservative investment with slightly more risk than a money market fund. His goal is to try and produce more income for himself.

Gary, it's understandable that folks like you are searching for higher yields since money market funds are currently yielding about 1.3 percent annually. Interest rates have been on a decline for more than 20 years now. In the early '80s money market funds yielded 19 percent and you could buy 30-year Treasury Bonds yielding over 15 percent.

So it is quite understandable that many investors are now more willing to take on additional risk by moving investments from money market funds to what they perceive as conservative higher-yielding bond funds without the knowledge that if interest rates rise the value of their bond or bond funds will fall. The opposite is true too. That is, when interest rates fall the value of bonds or bond funds will rise.

Therefore, we need to view the yield on your money market fund in its proper context. Inflation is low and will probably remain low for the next few quarters as the economy begins to recover from the recession.

As the economy recovers, we should begin to see an increase in inflation prompting the Federal Reserve to begin raising interest rates. When this happens the yield on your present investment in money market funds will begin to increase. If you moved your money market investments to bonds to try and achieve a higher yield, the principal value of your bonds would decrease in value.

What Can an Investor Do?

Since no one, not even Federal Reserve Chairman Alan Greenspan, knows the direction of interest rates longer term, there are techniques for investing in bonds that are fairly conservative and based on one's time horizon.

So here is a recommendation I believe will work for you as long as you don't panic and sell the investments prematurely:

1. Short-Term — Money that you know you will need during the next 12 months should remain in the money market fund.