Editor s note: As the market s woes drag on into 2009, investors are looking for something anything to serve as an alternative to stocks. In this special report, SmartMoney examines three of those alternatives bond funds, cash accounts and gold to see where the opportunities and the pitfalls lie. >
Before the market crashed>, John Hayes never gave much thought to cash. A retired car salesman from Chicago, Hayes used to go online to see how his stock and bond funds were doing. But now he's scouring the Web for better rates and higher yields -- anything to eke out a decent return on his $350,000 cash stockpile.
It isn't easy. The yield on Hayes's money-market fund has dropped by more than a third, and the once-high rate on his savings account has fallen too. He could earn more on a certificate of deposit, but he'd rather not tie up his money. And he's certain inflation is lurking, ready to whittle away his purchasing power if he can't earn some interest. It's more than a little frustrating, he says: "I want to be conservative, but I'd still like to get something."
Preach it, brother. Investors are sitting on a record amount of cash, only to wonder what the heck to do with it. The credit crisis shook the bond market right along with stocks, leaving cash as the most reliable place to seek short-term shelter. There's nearly $4 trillion in money-market funds, and bank deposits grew 11 percent last year, to almost $8 trillion, as savers bailed out of other investments. And cash isn't losing its cachet anytime soon: In response to the market meltdown and recession, the savings rate is expected to grow to more than 5 percent in 2009, higher than it has been in 15 years.
But the financial crisis has also made the calculus of cash more complicated than ever. The Federal Reserve has cut rates and kept them low, making it harder for investors to earn a decent return. The average money-market fund now earns just 0.77 percent, or $770 a year on a $100,000 investment, and some savings accounts pay less than 0.5 percent. At the same time, the crisis has made some banks so desperate for deposits that they're paying more than 2.5 percent on some high-yield savings accounts. That could be a difference of $2,000 a year on a $100,000 account.
More challenging still, the options for cash have exploded. Between banks and money funds, investors have roughly 9,200 places to put short-term cash and access to all of them via the Internet. Brokers, meanwhile, are selling from separate lists of CDs, with their own terms and conditions. And no matter what you choose, there can be penalties, fees and disclosures that you'll miss without a magnifying glass. Even financial professionals find it confusing, says Bob Laura, a wealth manager at First National Bank in Howell, Mich., who's been buying CDs for clients recently. "You have to be extra careful."
Especially now. Forecasters predict the economy will get worse before it gets better, so investors may find themselves on the sidelines for a while. Another reason cash reigns today: With unemployment on the rise, having an emergency fund no longer feels like a luxury you can get around to eventually. So with an eye toward safety, returns and the fine print, we looked at three ways to keep your cash without losing your shirt.
With bailouts and financial scandals in the headlines daily, Richard Dukas started to worry that, with more than $1 million in one bank, he'd put too many eggs in one shaky basket. So one day last fall, during the 18-block walk from Manhattan's Port Authority Bus Terminal to his office, Dukas stopped at three banks, buying a $100,000 six-month certificate of deposit at each. No comparison-shopping for Dukas, who owns a public-relations firm in New York. "I just wanted it to be safe," he says.
CDs, also called time deposits, are essentially a contract with a bank. In exchange for a set rate, the customer agrees to leave money in the bank for a defined period. Every bank sets its own rates, and experts say it's fair to assume that the higher the rate, the more a bank needs your money-possibly because it's in trouble. Rates on 12-month CDs currently hover just under 3 percent, but Jason Sherman, a small-business owner in Oak Park, Ill., recently found a 4.35 percent interest from GMAC Financial, part-owned by beleaguered General Motors. (A GMAC spokesperson says the bank is well capitalized.)
Sherman figures that even if the bank were to go under, the Federal Deposit Insurance Corp. would cover his losses. Investors who bought what were called CDs from the now-infamous Stanford International Bank weren't so lucky. The government says the bank put the money into illiquid assets and that it didn't have FDIC insurance. An FDIC spokesperson says investors can check the FDIC Web site to see if their bank is insured. If it is, the government insures deposits and interest up to $250,000; the limit is scheduled to drop back to $100,000 after Dec. 31.
Buying from a broker, however, means learning a whole new playbook. Brokerages buy CDs from banks and sell them to investors; then the CDs trade like bonds. Hold them to maturity and they're like any other CD: You get your principal back, plus interest. But investors who need the money early are at the mercy of the market-a fact that brokers, who don't devote a lot of time to managing cash, aren't always diligent about explaining. Unlike banks, which spell out penalties for cashing in before the due date, brokerages typically sell your CD to someone else. If the interest rates are higher than when you bought it, you could lose money. That's why experts recommend buying CDs that come due in three-month increments; that way, an investor will always have some cash coming in.
For more than 40 years, money-market funds offered the ease of savings accounts, the privileges of checking and rates better than both. It didn't matter how the funds worked-they just did. But the credit crisis has sent yields to new lows. "We've been shocked," says Adam Miller, a financial planner in Colorado who has used such funds to hold his clients' cash for years. "Now we've got to be more creative."
Most investors know that money funds invest in different kinds of short-term debt. Some buy only Treasury bills, others invest in government agency debt, while prime funds add corporate bonds to the mix. It is corporate debt that forced the notorious Primary Reserve fund to break the buck. Its investors lost 3 percent, their supposedly liquid cash was frozen for months, and money-fund investors everywhere ran for the bersafety of Treasurys, driving yields almost to zero. The Treasury Department, trying to stop a panic, insured investors' money-fund balances as of Sept. 19. (The program is set to expire Apr. 30 but could be extended.)
These days many money-market funds pay less than $100 a year on a $100,000 investment, and fund companies are waiving fees and expenses to keep investors from losing money. Some, like JPMorgan, intend to allow their Treasury and government funds to invest in corporate bonds that are now, as a result of the financial crisis, also insured by the FDIC. That might mean higher yields-so the firms could stop waiving those fees and expenses. But will they be safe? Connie Bugbee, of money-fund research firm iMoneyNet, says she's not worried. But, she adds, "there are still some risks. These are not Treasury securities." Investors who are comfortable with those risks might be better off in prime funds, but even there, the top fund is paying just 1.38 percent.
Even with the crummy yields, money funds still have advantages. Brokerage money funds offer flexibility for investors who want to jump quickly in and out of the stock market, and wealthy investors in high-tax states might prefer a tax-exempt money fund, which invests in that state's municipal bonds. But otherwise, Bugbee recommends savings accounts and CDs, noting that even a 2 percent yield would beat money funds.
Savings and Checking
As the economy worsened, Linda Mastaglio, a small-business owner in Van, Texas, made sure she had six months of expenses, $70,000, set aside in case of emergency. But over the course of last year, her savings account rate dropped to 1.8 percent-a far cry from the 3 percent she got when she first socked away the money. Mastaglio can't find a better-paying Plan B, and she isn't pleased: "How frustrating is this?"
Plenty of banks today advertise high rates for everyday products like checking and savings accounts. But as Mastaglio found, there's usually a catch. Some accounts offer a high rate, but just for the first three months; others require high minimums to qualify for the best rate. In some cases, the rate drops if customers use their debit card too seldom-or too often. There's nothing nefarious about all this, but it makes for a lot of fine print to read.
Still, investors willing to put up with the rules can find good deals in unusual places. Long considered investment dogs, some interest-bearing checking accounts are now offering competitive payouts. At ING Direct, depositors with a balance of $50,000 earn 1.75 percent. (Slightly better than an ING savings account, but not as much as most six-month, $50,000 CDs.) About 560 community banks offer rates on checking of up to 6 percent, even on low balances-as long as the investor banks online and uses a debit card a few times a month. It's all up to the bank, says Gallup consultant Douglas Berlon. "They're all looking at their own balance sheets and pricing accordingly."
Finding the highest rates isn't hard. Bankrate.com keeps a daily tally and rates banks' supposed safety with a five-star system. At MoneyAisle.com, banks bid for customers' accounts. Only highly rated banks participate, says CEO Mukesh Chatter, but combing through the terms and conditions is up to the user. One sneaky fee to watch out for: pricey ATM charges that could eat up your interest. In 2008 investors paid almost $3.50, on average, to use an out-of-network ATM. Hit the cash machine twice a week with fees like that and at 2.5 percent interest, you'd need to maintain a balance of more than $14,000 just to cover your annual charges.
Read the rest of our special report: