The average yield on one-year bank certificates of deposit (CDs) is now over 5 percent, according to www.bankrate.com. With a little searching, you can find annual returns up to 5.65 percent on a five-year CD. At the same time, the average payout from money market funds is now about 4.8 percent while yields over 5 percent are available.
Just a few years ago, yields from CDs and money funds were around 1 percent, or even lower. After 17 interest rate increases by the Federal Reserve, savers once more can get a decent return from these safe, liquid cash equivalents.
Even now, though, the “yield curve” is flat. That is, the interest rate you’ll receive on a two-year bond or a 10-year bond is not much higher than the yield you’d get on a bond maturing in one year.
Therefore, you might want to avoid investing in bonds now. Keep your money in short-term CDs and money market funds where you’ll get bond-like returns with little risk.
Besides using cash as a bond substitute, you should hold cash for spending and for possible emergencies. Many advisors suggest holding six to 12 months’ of income in a day-to-day checking account or a money market fund. If you spend $3,000 a month (after paying taxes and making investments), for example, you might keep $18,000 to $36,000 in accounts that can be easily accessed.
Today’s higher yields on cash also may help you invest in stocks. If you come into a sum of money that you’d like to invest in the market, you can “dollar-cost average” over six months. A $60,000 inheritance, for example, might be invested at $10,000 per month while the balance is parked in a money market fund.
This go-slow strategy will allow you to avoid investing all your money at a market top. Meanwhile, with 5 percent interest rates on cash reserves, you’re be paid while you wait. In fact, if money market yields keep rising, to 7 percent or 8 percent, you might just keep your money in these low-risk vehicles and avoid stock market risks altogether.
Holding onto cash may be an especially good strategy if the Fed indicates that inflation is not under control. Higher inflation probably will lead to higher interest rates and those higher rates not only may hurt stocks and bonds, they’ll raise the yields on cash. In 1981, for example, after many years of high inflation, money market funds were yielding 17 percent.
