Bank savings are safe but yields are pitifully low, causing many savers to reach for bigger yields in short-term bond funds. But the results are so modest it may not be worth the trouble.
Today, the average savings account pays just 0.195%, and the average money-market account only 0.282%, according to the BankingMyWay survey. That’s about as close to nothing as you can get, especially with inflation taken into account. But at least your principal is safe.
What could you earn in a short-term bond fund? Christine Benz, director of personal finance for Morningstar Inc., the market-data firm, has recommended a few candidates that can pay better than bank savings but still be relatively safe.
Benz suggests investors divide their rainy-day funds in two, putting several months worth of money in real cash such as bank savings, and steering the rest toward short-term bond funds with higher yields.
Unlike long-term bonds, short-term bonds tend to hold their values fairly well when interest rates rise. That’s because investors will get their money back soon, so they won’t suffer below-market yields for very long.
Benz looked for short-term bond funds that have been less risky than their peers. She focused on those with very low fees and no loads, or sales commissions, as any type of charge can seriously undermine yields when interest rates are as low as they are today.
Her search produced three funds: the T. Rowe Price Short-Term Bond Fund (Stock Quote: PRWBX), yielding 2.86%; USAA Tax-Exempt Short-Term Fund (Stock Quote: USSTX), yielding 2.59%; and Vanguard Short-Term Bond Index (Stock Quote: VBISX), yielding 2.28%.
With a five-year CD you’d lose six to 12 months interest if you took your money out early, while there’d be no early withdrawal penalty for a short-term bond fund.
On the other hand, the three bond funds require $2,500 to $3,000 to open an account. And sometimes, there is a risk of loss. The Vanguard fund, for example, has a “duration” of two and a half years. That means the fund share price could fall by 2.5% if prevailing interest rates rose by 1%, wiping out a year’s worth of interest earnings.
And these bond-fund yields, though dramatically higher than bank yields on a percentage basis, won’t make anyone rich. Invest $10,000 in the T. Rowe fund and you’d earn $286 a year, compared to $28.20 in the average bank money-market account. For many savers, that difference may not be big enough to offset the risk of loss in the bond fund if rates rise. After all, interest rates are so low today they’re more likely to go up than down.
A rainy-day fund needs to be safe and accessible. Bank savings meet the test well. Use the search tool to see how your bank stacks up against the competition.
—For the best rates on loans, bank accounts and credit cards, enter your ZIP code at BankingMyWay.com.