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Getting a Decent Return on Safe Investments

by: Jonathan D. Pond, from: AARP, Updated October 2011

The investment industry offers several "safe money" alternatives under the umbrella of "short-term investments," "temporary investments," or, in the Wall Street lexicon, "cash equivalent investments," or just plain "cash."

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Investment Choices

Available Through Banks or Credit Unions:

Savings accounts. Federally insured, but usually pay low interest.

Money market deposit accounts. Federally insured, but usually low interest, although some institutions offer returns that are competitive with brokerage money market funds.

Available Through Mutual Funds or Brokers:

General money market funds. Usually pay highest interest among money market funds, but investors who are concerned about safety might opt for government or Treasury money market funds. The federal government has provided some money market fund guarantees to participating fund companies and brokerage firms, but only under certain conditions. Check with the institution that holds your money.

Government money market funds. Considered safer than general money market funds, but have a lower yield.

U.S. Treasury money market funds. Safest money market funds, but interest paid is very low.

Tax-exempt money market funds. Interest is exempt from federal income taxes, so investors in high tax brackets might benefit.

Single-state tax-exempt money market funds. Interest is exempt from both federal and state income taxes, but be wary of unusually high yields, as this may indicate fiscal problems in the state.

Available Through Banks or Brokers:

U.S. Treasury bills. Ultra-safe, but interest paid may be almost nonexistent. Recently, a $10,000 investment in a three-month Treasury bill would have earned a mere $2.50 in interest. If a Treasury bill is not held to maturity, you may suffer a small loss of principal.

Certificates of deposit. Federally insured. Also available from credit unions. Likely to provide the best interest rates among safe investments, although it is advised that you compare CD rates against other alternatives. An interest penalty is assessed if CD is sold before maturity.

These types of investments pay interest with little or no risk that you'd lose principal. With a couple of exceptions, you can also take your money out immediately with no loss of principal.

Some examples include certificates of deposit, money market accounts, money market funds, and U.S. Treasury bills.

There are a lot of reasons why you should have at least some of your money invested in these types of accounts without having to worry about the money losing value or suddenly becoming inaccessible.

For example, it is a good idea to have a few months' living expenses in an emergency fund where you can easily access it. If you're retired, you might want to keep enough of your retirement investments in safe securities to fund up to two years' worth of living expenses. This will prevent you from having to sell other investments at a loss if the market continues to decline.

Having money in these investments also makes it easy to meet foreseeable short-term cash needs that can't be paid for out of your job income. These can include college tuition, home improvements, a car, or another big-ticket item.

Here are three essentials to consider when deciding where to put your safe money:

1. Safe. Whether fleeing the stock market or temporarily setting money aside to be used in the near future, you don't want to risk losing your principal.

2. Accessible. You want to be able to get your hands on the money within a day, ideally at no cost or at minimal cost.

3. Decent interest. You want to earn an attractive rate of interest. Since the interest rate paid (the "yield") on safe investments varies considerably, doing some comparison shopping will be rewarding, particularly when the interest paid on these investments is as low as it is now.