Back in 2007, when the economy and markets were still going
gangbusters, investors seeking "safe" high yields plowed their
money into all sorts of investments that claimed to be as secure and liquid as
cash while delivering above-average returns: auction-rate securities, bank loan
funds and ultrashort-term bond funds, to name a few.
These investments lived up to their extra-gain-with-no-pain
promise, until they didn't. When the financial crisis hit in 2008, it became
clear that supposedly safe alternatives to money-market funds and savings
accounts came with an unexpected downside.
The market for auction-rate securities froze up in 2008,
leaving thousand of investors unable to access their money for many months and,
in some cases, years. Ultrashort-term bond funds, meanwhile, lost 9% of their
value during the financial crisis, while bank loan funds fell by more than 30%.
It took both types of funds nearly three years to recoup their losses.
Flash forward to today: With savings accounts, money-market
accounts and the like paying less than 0.10% a year on average, the impulse to
reach for extra yield is still strong. And there's no shortage of people pitching
products that cater to that impulse, ranging from the very ones that
backfired on investors six years ago (bank-loan funds, ultrashort-term bond
funds, short-term bond funds) to a variety of others offering even higher
yields (short-term commercial real estate notes and promissory notes). In
some cases, they are even touting double-digit returns.
Word of Advice: When it comes to the money that absolutely,
positively has to be there whenever you may need it -- emergency funds or
savings you expect to tap within a short period, say, a down payment for a
house you plan to buy within a few years -- you should stick to an FDIC-insured
savings account or money-market account. Granted, their yields are paltry. But
for the money you can't afford to put at risk, safety and access are your
primary concerns, not return.
That said, there is a way to boost the yield you earn
without sacrificing safety: do a little shopping around. By going to sites like
Bankrate.com, Mint.com and NerdWallet, you can find savings accounts, money
market accounts and short-term CDs that pay yields well above the average.
We're not talking blow-your-socks-off payouts, but you can
get 1% or so in an FDIC-insured account, which is roughly 10 times the national
average. On $50,000 of savings, that's the difference between earning $500 a
year vs. just $50.
It isn’t recommended, but if you want to shoot for a
somewhat higher return with a portion of your "safe harbor" stash,
you could move some funds into an ultrashort-term bond fund, bank loan fund or
even a short-term bond fund. But if you choose to do that, I suggest you
complete a risk tolerance questionnaire first. And if you decide to
go ahead, make no mistake that, one way or another, you're accepting the
possibility of a bigger downside.
In the case of ultrashort- and short-term bond funds, the
main danger is rising interest rates. At some point, the Federal Reserve will
set a higher target for short-term interest rates. When that happens, rates
will rise and ultrashort- and short-term bond funds will be susceptible to
setbacks.
Morningstar also noted in a recent report that
some funds holding short-term debt have been juicing yields by investing in
lower-quality bonds, making them even more vulnerable.
If you have some money you can afford to take extra risk
with in hopes of earning a higher return -- and you're willing and able to do
the considerable research needed to truly understand the risks in these complex
investments -- fine. But you should know that money in these investments is not
as liquid and secure as funds in an FDIC-insured account.
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