CDs and MMAs: A smart part of any
As the stock market lurches, certificates of
deposit and money market accounts look more attractive as a safe
harbor for your money.
There is a tendency to dismiss them as low earners
compared to the returns of previous years in the stock market, but
with the market downturn of late, CDs
and MMAs are looking mighty inviting.
CDs and MMAs make sense for savers in a variety
of circumstances. They make sense if you need to:
Diversify your portfolio
The bull market of the '90s made people
forget one of the fundamentals of wise investing: diversity. An
investor looking to diversify a stock-heavy portfolio across other
asset classes is a prime candidate for the safety, security and
high yields of CDs
Liquid cash should be kept in a high-yielding MMA.
Long-term cash can be invested in CDs to maximize
yield, providing the diversifying investor a method of locking in
this return for the next five years. These funds are FDIC insured.
Investors subject to state income tax may wish to discuss the tax
implications of the various alternatives with a tax adviser.
Establish an emergency fund
Everyone should have an emergency fund
for unplanned expenses. Rather than keeping this idle cash in low-yielding
checking or savings accounts, why not pursue a high-yielding money
market account? The money is FDIC insured and completely liquid,
meaning the money can be accessed at any time. Money
market accounts provide check-writing capabilities, making them
a perfect place to stash cash until it is needed, earning an attractive
yield in the interim, and without having to transfer the funds to
a different account when needed. This is an option available to
many people as an emergency fund.
Time the market
The investor looking to keep money in
cash, earn an attractive yield in the meantime and maintain the
liquidity necessary to jump back into the stock market at a time
he feels more appropriate, is a candidate for a high-yielding money
market account. Such accounts are FDIC insured and completely liquid.
Further, these accounts provide check writing
up to a certain number of transactions per month for those looking
to ease back into the market.
provide more-favorable yields, but may not be appropriate for this
type of money user. With a CD, the money is locked up for a period
of time and the investor runs the risk of not having the funds available
when ready to get back in the market. The penalty for early withdrawal
involves forfeiting part of the interest earned, more than negating
any yield benefit from a CD. Best advice is to stick with a high-yielding
Save for college
For parents of children approaching college,
can preserve capital while still earning attractive yields. For
example, a parent with a son or daughter entering 11th grade would
benefit by putting the funds in a laddered portfolio of CDs with
maturities of two, three, four and five years. Funds would mature
at the beginning of each college year for expenses such as tuition
Another possibility is laddering the portfolio
to have funds mature every six months (maturities of two years,
two and a half years, three years, etc.) coinciding with expenses
due each semester.
Retire in style
The ideal setup for retirees is a laddered portfolio
of five-year CDs, with the amount of time between CDs depending
upon how often a cash influx is needed (monthly, quarterly, every
six months, etc). CDs
having matured can be kept in a high-yielding
MMA until the cash is needed, prolonging the period the maximum
yield is earned.
Having a laddered portfolio of five-year CDs
earns higher yields than shorter-term CDs. The idea is to keep cash
that is not needed immediately earning the highest possible yield.
The tricky part is getting to the point of a laddered portfolio
Those approaching retirement should begin setting
this up now, with the first funds scheduled to mature shortly after
retirement. The remaining funds should be invested to mature as
needed, keeping in mind that only a portion of the entire portfolio
will be needed in the first five years of retirement. Proper apportionment
between CDs, bonds and equities is appropriate as investors may
live 30 years or more in retirement. Proper asset allocation between
capital preservation and investments that outpace inflation is key.
-- Updated: Aug. 16, 2001