Earn 4% on Your Savings

Still have cash parked in a money-market mutual fund? It's time to move it out. A year ago, when the stock market was in free fall and investors were seeking refuge, money funds were earning 2% or more. Now the yields, which track short-term Treasuries, are below 0.4%. Yet money funds still hold $3.5 trillion in assets, just about the same amount as they held a year ago, according to Money Fund Report newsletter. Prospects for higher rates are better at a bank, but even if you're willing to tie up your money for five years in a certificate of deposit, you'll be hard-pressed to find yields higher than 3.5%. And top one-year yields are only 2% or so.

Even as market forces undermine the earning power of your savings, don't let inertia add insult to injury. To find decent, supersafe yields now, you have to think outside the box. For example, you'll find some of the highest interest rates at community banks and credit unions. And your money is safe, as long as you know the limits of deposit insurance. If you're willing to step up the risk pyramid for a decent shot at higher returns, consider a short-term bond fund.

Safety plus high yields

You can earn as much as 5% on balances up to $25,000 (and sometimes more) at a community bank or credit union. For example, Union State Bank in Atchison, Kan., pays 5.01% on up to $25,000 in its My Rewards checking account. And you need a deposit of just $25 to open an account. (To find banks and credit unions with high-yielding accounts, visit CheckingFinder.com, and enter your zip code.)

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Yes, there's a catch to high-yield accounts: They come with a laundry list of restrictions. All banks and credit unions that offer them have more or less the same requirements. You must receive monthly statements by e-mail, use online bill pay, set up one monthly direct deposit or automatic payment, and use your debit card for purchases from ten to 15 times a month. The interest rate drops to around 0.3% at most institutions in any month that you do not meet the account's requirements, but it reverts to the higher rate if you meet them the following month.

Bobbi Bechtold of Godfrey, Ill., opened a free eSmart checking account at Liberty Bank, a small community bank in Alton, Ill. The minimum deposit to open the account was just $1, and she's earning 4.01% interest on balances up to $25,000 (for higher balances, the rate drops to 1.25%). Liberty Bank reimburses ATM fees from other banks up to $20 a month. To help meet the 15-times-a-month debit-card requirement, Bechtold's husband, Don, uses his card when he picks up his morning cup of coffee at McDonald's. Bechtold keeps the account balance as close to the $25,000 limit as possible by replenishing the funds from savings after she and Don use their debit cards.

Bechtold found Liberty Bank when she searched the Web for the best rates. She used to have accounts at megabanks, such as US Bank and Bank of America, but now she prefers doing business at a community bank "where you know everybody."

Credit unions are in stiff competition with banks for deposits. On average, they currently offer higher yields than banks on deposits and lower rates on loans and credit cards, according to a recent survey by Datatrac. When some of their CDs came due, John Eckley and his wife, Kathleen, each opened an Xtraordinary checking account at Connexus Credit Union in Wausau, Wis. "I could earn far more than on any other checking or money-market account," says John. Connexus accepts members from anywhere in the U.S. (you can join the Connexus Association for just $5). Or you could join Pentagon Federal Credit Union, even if you're not a member of the military, by paying a one-time, $20 membership fee to the National Military Family Association.

Bank money-market deposit accounts, which are also insured by the Federal Deposit Insurance Corp., are another option, but they yield 2% or less. You can open an MMDA at Flagstar Bank, in Michigan, with just $1 and pay no monthly fees. The account, which recently yielded 1.82% on balances up to $1 million, comes with a Visa debit card that you can use surcharge-free at more than 32,000 ATMs. By law, you can transfer funds or make withdrawals from a deposit account only six times a month, and only three of those transactions may be made with your debit card.

If you don't need to write checks, consider a savings account. For example, you can earn 2.3% on up to $100,000 in deposits at Tennessee Commerce Bank. Keep $250 in your account, and you avoid all monthly fees. You're entitled to one free ATM withdrawal a month; you pay $2.50 for each subsequent withdrawal.

Create a CD ladder

For sums above $25,000, certificates of deposit still offer the best combination of safety and yield. CD rates keep "slip-sliding away," says Greg McBride, of Bankrate.com. So shopping around is more important than ever. Yields from the top-paying banks range from 1.8% to 3.5%, depending on maturity.

A bank that offers a high yield in one maturity typically offers the best rates in other maturities as well. State Bank of India, in New York, which is the U.S. operation of India's largest bank and a member of the FDIC, is among the top yielders in five of the six maturities from six months to five years. Ally Bank, formerly known as GMAC Bank, and Discover Bank are among the institutions offering the best rates in all six categories -- although neither offers the highest rate in any maturity.

A good way to invest in a CD portfolio is to create a ladder of CDs with maturities that range from six months or a year up to five years. That way you can take advantage of higher rates when you reinvest your shorter-maturity CDs, while still earning higher yields on longer-term CDs. CD rates are likely to rise when the Federal Reserve raises short-term interest rates, but that probably won't happen until a year from now, if then.

As of January 1, 2014, deposit-insurance limits revert from $250,000 to $100,000 per depositor per bank or credit union. If you have more than $100,000 to invest in CDs that mature after 2013, divide your cash among several institutions.

More risk, more reward

No uninsured financial instrument is bulletproof. But that doesn't mean you should rule out all funds that invest in short-term bonds and bank loans. Yes, a few short-term bond funds lost more than 20% last year during the credit crisis. But for the most part, the types of funds designed to yield a few percentage points more than certificates of deposit and money-market funds without great swings in net asset value (or NAV, a fund's share price) have kept up their dividends. And as credit conditions improve, NAVs are recovering.

If your priorities are to make sure your principal is safe and obtain a small yield advantage over a bank account, look for three things: a long record of steady monthly payouts, low expenses and stable net asset value. Steer clear of any fund that's using borrowed money (leverage) or trading exotic instruments such as interest-rate swaps. And because of the risk that higher interest rates pose, focus on funds that invest mostly in short-term bonds (bond prices move inversely with interest rates; in general, the longer a bond's maturity, the greater its price swings with changes in rates). In that regard, several funds stand out.

A good place to start is Vanguard Short-Term Investment Grade (symbol VFSTX). Vanguard bond funds rarely play games -- what you see is what you get -- and they benefit from low fees, which are particularly important in a low-interest-rate world. This fund's annual expense ratio is just 0.21%. Despite investing in bonds with an average credit quality of single-A and an average maturity of less than three years, the fund lost 4.7% last year-disappointing but tolerable considering the damage many other short-term bond funds sustained. Vanguard Short-Term has recovered nicely in 2009, gaining 12.2% through September 22. The fund sports a current yield of 2.8%.

Technically, you can't call Ginnie Mae funds cash substitutes, but they play the part as if they were born to it. Ginnie Mae funds own packages of home mortgages, not short-term debt, but the funds kept their value through the financial crisis. That shouldn't come as a surprise because Ginnie Maes are backed by the full faith and credit of the U.S. government, making them much sounder than other mortgage-related investments. Vanguard GNMA (VFIIX) has a much lower duration (a measure of interest-rate sensitivity) than GNMA indexes or other funds, so rising mortgage rates shouldn't hurt much. Vanguard GNMA returned 7.2% in 2008 and has gained 4.5% so far this year; it yields 3.8%. In addition to Vanguard, Fidelity, Payden, Pimco and T. Rowe Price all have fine GNMA funds.

If you're willing to take on more risk, consider a bank-loan fund. Fidelity Floating Rate High Income (FFRHX), with a current yield of 4.4%, is once again an attractive place to store some cash now that we've seen the worst of the recession. The fund, which invests in loans made by banks to companies with below-average credit ratings, lost 16.5% last year because of the credit crunch. But it's rebounded with a vengeance this year, gaining 25.9%. Monthly cash payments are half what they were a year ago because the interest rates on those bank loans reset periodically and have trended down along with other short-term rates. When the Federal Reserve starts raising short-term rates, Fidelity Floating Rate will make bigger distributions.

Among tax-free funds, consider Alpine Ultra Short Tax Optimized (ATOIX), which owns tax-exempt securities close to maturity. It actually made money last year, producing a total return of 3.6%, and it's gained 2.9% so far this year. Manager Steve Shachat says that one way he guards against losses is by refusing to buy sharply discounted bonds in hopes of capturing a capital gain. At last report, Tax Optimized had more than 70% of its assets in variable-rate demand notes -- long-term debt securities with floating interest rates. The fund yields 2.7%, which is equivalent to 4.2% from a taxable investment for someone in the 35% federal tax bracket.

Another standout in the tax-free arena is Fidelity Intermediate Municipal Income (FLTMX), a member of the Kiplinger 25. As the name indicates, the fund invests in medium-maturity bonds (as of September 22, its average duration was 5.2 years, suggesting that the fund's NAV would drop 5.2% if interest rates were to rise one percentage point). But rates aren't likely to be heading up anytime soon, and the fund, under manager Mark Sommer, has been a steady performer. It eked out a 1% return last year and so far this year has gained a solid 8.7%. The fund yields 2.8% tax-free, equivalent to a taxable 4.3% for an investor in the 35% federal bracket.