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Holding cash is a lousy option these days.


Federal Reserve's

rate cuts have driven down rates on CDs, money-market funds, interest-bearing checking and savings accounts -- places where people traditionally keep a cushion of cash for emergencies -- and left fixed rates on loans intact.

So why keep a cash cushion at all?

The purpose of a cash reserve is to be able to pay for unexpected emergencies. "You don't want to take too much risk with that," says James. J. Holtzman, an adviser with Pittsburgh-based Legend Financial Advisors. But, he adds, "rates right now are really miserable."

No kidding.

Bank of America

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has created an online advertising video to advertise its "high yield" $5,000 four-month 2.5% APY CD. At that rate you'll likely lose money: Inflation topped 4% last year and taxes further eat away at earnings.

Standard-yield CDs fare even worse: Yields on five-year $10,000 CDs are running at about 3%, about the same as major money-market funds.

But everyone needs quick access to cash, especially with the looming threat of recession: Jobs are less secure, the credit crunch has made it harder to access cash through home-equity loans and no one wants to be held at the mercy of credit-card issuers' ever changing rates.

Here are five ways to get the best income from your emergency fund.

1. Short-Term 'High-Yield' CDs

The upside: You still probably won't be keeping up with inflation, but at least your money's not going to be losing value quite as fast. You might even beat inflation if you open a new account at a credit union that offers teaser CDs, but you'll likely only be able to invest a small amount of money.

The downside: "The logistics of it are annoying," Holtzman says. Often you have to have a checking account with the bank to be eligible for the rate. And a few months later you'll be shuffling your money around again, hoping rates rise despite the economic downturn -- or searching for another short-term promotional rate.

2. Municipal Bonds

They're not risk-free -- especially in an economic downturn -- but some municipal bonds are as close as you're likely to come. And unlike CDs or money market funds, earnings are tax-free.

In some municipalities you may be able to get a higher return than you would investing in CDs and money market funds, says Robert Reed, Director of Investments for Louisiana-based Personal Financial Advisors. And if you're in the top tax bracket, your after-tax return is ultimately doubled. For some, the increased income might be worth the increased risk.

3. Pay Off Debt

No point earning less than 2% on your savings when you're paying 12% on a credit card. Pay back your debt now, free up money to save later.

You could also consider paying off student loan debt (likely costing you 6.8% or more) or your car loan or mortgage. But keep in mind -- emergencies are almost always unexpected, and tapping into your home equity or getting a raise may be getting harder in the months ahead. Also, some loans come with pre-payment penalties which can eat away at the advantages of making early payments.

4. CDs With Few Restrictions

Some banks are offering CDs without early withdrawal penalties. So if CD rates go up, you'll be able to cash out of the old CD and get a new one with a better rate.

Bank of America, for instance, is offering a nine-month CD at 2.4% for consumers who invest at least $5,000. If you find a better rate a few months down the road or you need the cash, you're free to pull your money out -- as long as you reinvest it in a Bank of America deposit account.

The flexible terms make such CDs an attractive option for your emergency fund. "If you're going to have to keep money in the bank anyway, I would stick it in that," says New York certified financial planner Cary Carbonaro. "Even more so if we're going through a recession."

5. Avoid Exotic Investments

Each rate cut by the Federal Reserve makes investing in assets with some risk more appealing. But beware: Nothing is as safe as cash.

Case in point: Several banks allegedly hocked auction-backed securities as safe substitutes for cash. After they lost value in February, a rash of lawsuits accused the banks of deceptive advertising.

You may make more money investing your emergency money in high-rated corporate bonds or a diversified mutual fund. But then again, you're taking a risk.

You'll pay for it, but keeping your emergency money in cash, Carbonaro says, is at least "a place to park it that will let you sleep at night."