Better Rates for Savers, Finally

Goose eggs begone. Whether you save at the bank or park substantial sums in a money market fund at your brokerage between transactions, you no longer have to settle for zero interest. Today, an FDIC-insured savings account at an online bank pays as much as 1.25%. That’s the base rate for earning a risk-free return. To bend a phrase, cash now pays enough to say that all your dollars matter. Moreover, the “opportunity cost,” or forgone income, for settling for next to nothing in a checking account or brokerage cash drawer is rising.

The spark for the recent rise in yields is the Federal Reserve’s decision to move away from an extraordinarily easy monetary policy and steadily raise the federal funds rate, a key short-term benchmark. Some yields, such as those for one-year and two-year Treasury notes, have already more than doubled since last summer. As a result, many banks that had been stubbornly clinging to near-0% rates have become more willing to compete with the Treasury and money market fund sponsors.

Stay the course. None of this is to suggest that I’m bearish on stocks or longer-term debt. The Fed’s plan to bump up overnight rates twice more this year and three times in 2018 is barely registering on long-term interest rates, which are set by investors in the bond market and continue to swing within a narrow range. The market values of my favorite types of bonds, which include triple-B-rated corporate debt, tax-exempt revenue bonds and taxable Build America municipals, remain firm.

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Dividend yields, averaging 2.0% for Standard & Poor’s 500-stock index, are still high enough to attract new money to stocks. So high-yielding shares are keepers, too.

Now, back to your cash. Besides online bank accounts, the following are safe and liquid repositories. I suggest funds for convenience, but individual bonds maturing in two years or so offer good value. Even if rates rise and prices dip a hair, you’ll get back face value at maturity. Then you can roll the proceeds into higher-paying bonds.

Tax-free money market funds. Local governments borrow from banks or sell the equivalent of Treasury bills to meet their short-term needs, and the Fed influences these rates. Such ace funds as Northern Municipal Money Market (symbol NOMXX) and Vanguard Municipal Money Market (VMSXX) have gone from paying nothing last year to paying about 0.64% today. And their monthly distributions are rising. If you are in the top, 43.4% federal tax bracket, a tax-free 0.75% is equivalent to 1.3% from a taxable fund. (Yields are as of March 31.)

Ultra-short-term bond funds. These funds’ holdings typically have average maturities of about one year, making them nearly impervious to rising rates. USAA Ultra Short-Term (UUSTX, yield 1.3%) tends to yield more than its peers, but the monthly income for all funds in this category should grow as they replace holdings with higher-yielding debt.

Short-term corporate bonds. With slightly longer maturities than ultra-short-term products, these funds carry a bit more interest-rate risk but also yield more. You need not look beyond Kiplinger 25 member Vanguard Short-Term Investment-Grade (VFSTX, 2.0%), whose holdings have an average maturity of 3.3 years.

Floating-rate bank-loan funds. I wrote about these funds in the December 2016 issue, and they’re also featured prominently in 29 Ways to Earn 1% - 10% on Your Money in 2017. My favorite is still Fidelity Floating Rate High Income (FFRHX, 3.0%). The bank loans it holds usually have below-investment-grade ratings, so you can’t precisely call such a fund a cash instrument. But the fund carries almost no rate risk, and you can sell it as easily as you can any other mutual fund.