Net Gains: Where to Put Your Savings

April 16, 2008 — -- All across America, there's a search going on. It's a search for higher yields on savings that don't jeopardize the safety of principal.

For the time being, however, it could be a frustrating and fruitless search. Most bank CDs pay less than 4 percent, two-year Treasury notes less than 2 percent and top quality money market funds somewhere in between.

All the while, grocery bills are on the rise and gasoline prices show no signs of dropping.

What's an investor to do?

First, know your options are limited for now if you're seeking safety at a decent rate of return. You may be tempted to stretch for higher yield, but unless FDIC insured, anything advertising more than a 4 percent interest rate right now is going to entail some level of risk.

"The options are pretty plain vanilla," Michael Chamberlain of Chamberlain Financial Planning in Santa Cruz, Calif., says. "The important point is to not chase a higher yield in an investment that you do not understand."

He cited as an example complex annuities that offer high initial rates but then lock you in for the long term at low rates.

Or consider the example of the Schwab Yield Plus Fund, an ultra short-term bond fund with a stated goal of "high current income consistent with minimal changes in share price." Despite the goal, this fund used by many as a holding bin for short-term cash has dropped about 24 percent this year as a result of large stakes in mortgage-backed securities that have been crushed in recent months.

The Schwab fund held $13.5 billion in assets less than a year ago; now it stands around $2.5 billion, according to Morningstar, as shareholders have fled and some have joined in class-actions against the fund.

This is an extreme example, but Schwab Yield Plus is far from alone among ultra short-term bond funds used by those seeking higher returns than those available from CDs or money market funds. As a category, ultra short-term bond funds were down 1.9 percent for the year through the end of last week, Morningstar data show.

"There are risks anytime investors stretch for yield," says David Kaiser, president of Pinnacor Financial Group in Denver. "We are advising clients to just be patient. This too will pass and the markets will return to a more normal risk-reward scenario within one to two years."

Along with ultra short bond funds, savers who want to be sure their principal is safe may also want to steer clear of short-term corporate notes marketed by some large companies to small investors as a place to park cash. For instance, General Electric touts its GE Interest Plus program with "Higher rates of interest than other cash alternatives like FDIC-insured savings accounts, short-term CDs and money market mutual funds."

But short-term notes like these amount to an unsecured loan the investor has made to the company. If the company encounters financial difficulty, the investor will stand behind the holders of secured debt when it comes time to get repaid.

As GE discloses on the GE Interest Plus Web site, corporate notes are not FDIC insured, and "unlike short-term bond funds or money market mutual funds, they are not diversified pools of investments."

GMAC and Ford Motor Credit Co., among others, offer similar short-term notes that carry all the risk of a single company's performance.

Chamberlain, the Santa Cruz, Calif., financial planner, said for clients stashing small amounts of cash or those who need liquidity, he recommends they shop for a competitively priced CD with a term that matches their needs. "It is to the client's advantage to call a number of banks and compare rates and terms," he said.

The best rates are often available to those willing to do their banking online rather than in person. Earlier this week, IndyMac Bank of Pasadena, Calif., was advertising a one-year CD with an interest rate of 4.10, but that rate was available only to accounts opened online.

According to Bankrate.com, the average rate nationally for a one-year CD stood at 2.91 percent Monday. For a five-year CD, the national average was 3.26 percent.

For those who don't want to shop CD rates regularly, Chamberlain points clients to the Vanguard Prime Money Market Fund. "It historically has provided above average yields and Vanguard is easy to work with," he said.

Vanguard Prime Money Market Fund featured a yield of 2.6 percent Monday.

Jeff Eschman, a financial planner with Brazos Financial Advisors in Houston, advises savers to look at Countrywide Bank's SavingsLink account. It is an online-only, FDIC-insured account paying 3.97 percent on accounts with $10,000 or more.

For those who lost money in the Schwab Yield Plus Fund, Eschman suggests "turning lemons into lemonade" by using the loss to offset capital gains in other taxable investment accounts and "move into something that's better suited as a true cash haven."

This work is the opinion of the columnist and in no way reflects the opinion of ABC News.

David McPherson is founder and principal of Four Ponds Financial Planning (www.fourpondsfinancial.com) in Falmouth, Mass. He previously worked as a financial writer and editor for The Providence Journal in Rhode Island. He is a member of the Garrett Planning Network, whose members provide financial advice to clients on an hourly, as-needed basis. Contact McPherson at david@fourpondsfinancial.com