(Fortune Magazine) -- Where do I keep my cash? During times of financial crisis (like now), that's the question on many investors' minds. And when the financial crisis involves the credit markets (as it does now), the answer isn't so simple.
Keeping money in "cash" generally means putting it where it is guaranteed not to lose value and can be accessed quickly, with no fees or taxes. As some investors have learned the hard way, not all investments touted as "cash-like" meet those requirements.
The first scare came in August, when it turned out that money-market funds, long thought to be super-safe, had been buying risky mortgage-backed bonds. While no investors have lost money, fund sponsors, including trusted names like Janus (JNS), Wells Fargo (WFG), and Credit Suisse (CS), have had to step in to prevent some funds from registering losses.
Just how big a problem is it? In December, Janus took a $16.2 million charge when it bought such securities from its money-market portfolios. "They would rather reach into their own pockets and take earnings losses than incur the wrath of investors by fouling up a liquid investment that is supposed to be fail-safe," says Lipper senior analyst Jeff Tjornehoj.
The second near miss has come in the market for auction-rate securities - essentially long-term bonds that pay interest at a rate determined by periodic auctions. Some individual investors put money into funds that bought auction-rate securities believing they were similar to money-market funds but with slightly higher yields.
However, the credit crunch has put a crimp in the market, and several auction-rate funds, including ones run by Nuveen and Eaton Vance (EV), are frozen. Investors are still earning interest, in some cases at extremely favorable rates, but they can't get their money out.
What to expect
So where does that leave nervous people with money at hand? There are still safe options, but remember that safety means lower yields. "If you are getting more than a market rate on your cash, you are taking some risk, which is not cash investing," says Madelynn Matlock, a director at Huntington Asset Advisors.
Or as Peter Crane, head of money-fund research firm Crane Data, says, "Cash is the money you need on hand, so safety and liquidity are your first concerns. Yield comes after all of that."
If you keep your assets in cash while the storm passes, stick with the classic menu of investment options. That means Treasury bond money-market funds, high-yield savings accounts, and short-term CDs. Those options seem plain, but they offer the safety and liquidity that defines true cash investments. And take heart. You can still find decent yields by shopping around, but you have to shop carefully.
Let's start with the safest investments of all: short-term Treasury bills, or T-bills, which range in maturity from a few days to 26 weeks. You can buy bills directly from the Treasury at treasurydirect.gov; the minimum purchase is $1,000. (On Friday the Treasury Department announced that it would reduce that minimum to $100 as of April 7, in order to open up the market to smaller investors.)
Money-market funds that invest only in short-term Treasury bills were yielding an average of 1.9% recently, according to Crane Data. They carry zero risk of default, and because they are short term, no risk that rising interest rates will reduce their value.
Considering money markets
Bank money-market accounts, insured for up to $100,000 by the FDIC, are another super-safe choice. They recently yielded 3% on average, according to bankrate.com. But some are paying much more: Flagstar Bank in Troy, Mich., is offering 4.18%.
If you don't mind locking up your money for a few months, bank CDs offer similar protection and, sometimes, higher yields. Metropolitan National Bank in New York City is offering 3.46% on a three-month, $2,500 CD, while Corus Bank in Chicago is paying 3.79% on a six-month CD. You can check bankrate.com to look for the best rates.
If you prefer money-market funds, keep in mind that they are not guaranteed to maintain their value. Stick with companies known for low expenses and conservative management, and likely to stand behind their funds, such as Vanguard, Fidelity, and T. Rowe Price. The average money fund yields 3.4%, according to Lipper, and the average tax-exempt money fund yields 2.4% -equivalent to 3.7% for someone in the 35% federal tax bracket.
Finally, remember that inflation - currently running at about a 4% annual rate - erodes the value of cash holdings. So don't keep your money parked forever.
Says Matlock: "Once the market chaos clears, you can take advantage of opportunities you would have to miss if you weren't in a low-yield but secure and liquid investment now."
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