MMAs make the most of meager savings
money market accounts might be a better investment option than a
short-term CD now -- as long as the Federal Open Market Committee
doesn't cut interest rates again. The highest-yielding
money market deposit accounts currently yield in excess of 2
percent annually, a crucial threshold as inflation is currently
running at a similar pace. Meanwhile, the highest-yielding three-month
CDs are currently earning 1.5 percent, and the highest-yielding
six-month CD earns 2.05 percent.
In traditional circumstances, investors earn extra
yield for being willing to commit their funds for an increasing length
of time. This yield premium exists to compensate investors for tying
up their capital for a predetermined amount of time, and entice them
to do so instead of keeping the funds liquid. The exception to this
is in a declining rate environment, such as that witnessed over the
past three years. In the past several years, it has become commonplace
for the return on a six-month CD to reflect the expectation of falling
rates over the ensuing six months and carry a return lower than a
liquid investment such as a money market account. During that time,
the yield on money market accounts, which can change at a moment's
notice, offered no assurance of remaining intact for any period of
time and continued to decline as the Federal Open Market Committee
repeatedly cut interest rates.
But we've started to turn a corner.
With the economic rebound gaining momentum -- a factor
in the recent run-up in long-term interest rates -- the expectation
taking hold is that the Fed is done cutting interest rates. Yields
on certificates of deposit of all maturities reflect this expectation,
with long-term CD yields rising steadily and shorter-term CDs having
bottomed. While long-term CDs have posted consistent increases over
the past two months, investors are cautioned against tying up too
much money for too long at current levels. Investors then must look
to shorter-term instruments as a way to preserve the flexibility
to invest at higher returns on long-term instruments in the future.
But the yields on CDs with one year and less to maturity have yet
to show any substantive improvement and continue to linger at, or
near, record lows.
Opting instead for money market accounts, the highest-yielding
of which exceed that of short-term CDs, is a gamble that the Fed
won't need to cut interest rates again. This could be a gamble worth
taking. In the next six months investors will hear a lot more talk
about when the Fed will start raising rates and a lot less talk
about further Fed rate cuts. As this comes to fruition, not only
will the highest-yielding money market accounts also have bottomed,
but they will begin to rise as the timetable for Fed action becomes
more concrete. In the meantime, the investor preserves the ultimate
in liquidity while very likely outearning a short-term CD acquired
Yields on certificates of deposit face a long
road back to respectability. Little incentive exists to lock up
money at such anemic levels when yields are just beginning to show
signs of recovery. The highest-yielding money market accounts offer
investors a higher return than short-term CDs, a return that keeps
pace with inflation, and the flexibility to take advantage of rising
rates. Short-term CDs will eventually return to the traditional
yield advantage over liquid investments such as money market accounts.
But until that happens, investors choosing short-term CDs may be
settling for less.
Greg McBride is a financial analyst
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