Even before the Federal Reserve's latest rate cut, yields on money-market funds were dropping, leaving savers in a pinch. Now, the situation looks to get even uglier.
Still, a few attractive alternatives remain. These include higher-yielding certificates of deposits and, for those willing to take on a bit more risk, some short-term bond mutual funds.
Yields of money-market funds have been sliding since the Fed began a series of rate cuts in September to jump-start a slowing economy. The average seven-day yield for taxable money-market funds has dropped to 3.4% from 4.7% since then.
It gets worse. The Fed has slashed rates twice in the past 10 days, and those cuts have yet to be fully reflected in money-market-fund rates. By the end of February, the average taxable fund yield could be around 2.4%, says Connie Bugbee, managing director of iMoneyNet, a money-fund research firm.
There are other factors besides rate cuts that are pushing down yields on money-market funds. Such funds have been flooded with new cash as investors have become more risk-averse, which forces managers to buy more securities, even lower-yielding ones.
In recent months, many money-market funds have been reducing their investments in certain complex securities, some backed by mortgages, which provide higher yields. Now, questions are growing about another complex security backed by municipal bonds, which many money-market funds are holding. The upshot: Many money-market managers are buying more-conservative securities with lower yields, such as U.S. Treasurys.
The Fed's latest rate cut of half a percentage point -- on top of a surprise three-quarter-point cut last week -- will cause rates on savings accounts and certificates of deposit to fall even further, meaning savers should lock in yields now. Some banks, particularly ones with big mortgage-lending arms, are still offering surprisingly high yields on CDs.
"The good news is that rates aren't falling as fast as the Fed is cutting interest rates," says Greg McBride, a senior financial analyst at Bankrate.com. "The bad news is that they're falling faster than they were just a few weeks ago. There's no benefit to holding out because yields will continue to trend lower." Currently, the top-yielding deposit accounts range from 4.6% to 4.8%, compared with yields that were over 5% through the end of December, says Mr. McBride. Average yields on one- and five-year CDs are 2.75% and 3.09%, respectively.
Given the Fed's most recent cuts, "you can expect there will be quite dramatic cuts in bank rates across the board within a week," says Jim Kelly, chief operating officer at ING Groep NV's ING Direct, which currently offers rates ranging from 3.65% to 4.25% across its deposit accounts.
Financial firms that have been facing a credit crunch have been offering higher rates. As of yesterday, IndyMac Bancorp Inc., for example, was offering a seven-month CD at 4.8% with a minimum deposit of $5,000. Meanwhile, the banking unit of Countrywide Financial Corp., which is being bought by Bank of America Corp., is offering a three-month CD with a yield of 4.8% with a minimum deposit of $10,000.
In certain markets, consumers may be able to find higher rates by calling their local bank branch. In California, for example, Countrywide is offering a three-month CD with a yield of 5.10%.
In some cases, banks will offer higher yields to customers who also open up a checking account or meet other requirements. Washington Mutual Inc., for example, is testing a savings account that pays as much as 6.5% if the customer agrees to deposit money regularly for 12 months.
The account, which is being offered in four states, yields 5.5% in Washington and 6.5% in Illinois, Georgia and Texas. Withdrawals before the end of 12 months trigger a penalty. Local banks and credit unions may also offer higher rates, although customers may have to live in the area or meet other membership requirements.
For investors who don't need their cash for six months to a year, another option could be to invest in a high-quality short-term bond fund. Harold Evensky, a financial planner in Coral Gables, Fla., recommends looking at funds where the bonds have a weighted average maturity of two years or less, such as the BlackRock Low Duration Bond Portfolio. Currently, that fund has a 12-month trailing yield of 4.51%, according to Morningstar Inc.
Mr. Evensky is also using a tax-advantaged short-term municipal bond fund, Schroder Short-Term Muni Bond, which has a 12-month trailing yield of nearly 4%, according to Morningstar.
Bond funds are more risky than cash, since the value of the underlying securities will decline if rates pop back up. However, short-term bond funds experience far less radical gyrations than longer-term funds.
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