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MMAs make the most of meager savings rates

Greg McBrideHigh-yield 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.

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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 now.

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 for

For advice regarding your specific situation, please e-mail one of's Q&A experts or visit the Personal Finance Advice channel on

-- Posted: Aug. 29, 2003
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