Low interest rateshave worked wonders for debt-ridden
consumers. For those who have cash they need to invest,
however, low rates are causing a bunch of problems.
Although stocks have historically given investors the
best returns over the long haul, putting money you'll
need within the next few years in the stock market exposes
you to huge amounts of risk. If your timing's bad, then you
could run into the brick wall of a bear market and have to
sell at exactly the worst time.
That's why many savers stick with
less risky investmentsfor their short-term savings. Yet
with many low-risk savings vehicles having seen their income
dwindle to almost nothing, some are jumping into alternatives
that are riskier than they probably think.
The falling money-market fund
Perhaps the easiest way to set cash aside is through a
money-market mutual fund. Currently, investors have a
staggering $3.5 trillion set aside in money-market funds.
Yet according to the
Wall Street Journal, many savers have fled the
safety of money-market funds in search of higher rates.
That's not hard to believe, given that top-yielding money
market funds are paying out only 0.6%, and most clock in at
less than 0.25%. Faced with a paltry $20 per month income on
$100,000 in savings, many are making the classic mistake of
buying longer-term securities like bond funds at what may
prove to be exactly the wrong time.
The troubles of bond funds
Bond fundshave two major problems. First and foremost,
unlike money-market funds and other similar fixed products
like bank CDs, bond funds expose you directly to interest
rate risk. If interest rates rise -- which looks like an
increasingly likely propositionin the near future -- then
bond funds will drop in price. And unlike a bond you own
directly, a bond fund doesn't give you the option to get back
your full principal at maturity; you could be stuck with that
loss.
In addition, the investments that some bond funds make
aren't nearly as safe as a bank CD or money-market fund. For
instance, take a look at the
Vanguard Short-Term Corporate Bond
Fund (VFSTX). It has an average maturity of about 2.5
years and currently yields 2.79%. But take a look at some of
the companies whose bonds the fund owns:
Company
Value of Bonds Held
Alcoa (NYSE: AA)
$22.7 million
Bank of America (NYSE: BAC)
$228.1 million
Citigroup (NYSE: C)
$261.1 million
MGM Mirage (NYSE: MGM)
$10.2 million
Pfizer (NYSE: PFE)
$116.6 million Continued... |