CDs and MMAs: A smart part of any portfolio
By Julie Bandy and Greg McBride • Bankrate.com

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 and MMAs. 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.

Short-term CDs 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 MMA.

Save for college
For parents of children approaching college, CDs 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 and books.

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 of CDs.

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