The return on savings: Miserly

Question: My wife and I have been working diligently to save a good chunk of "cash on hand" money, as well as the down payment for our next house. We should have around $17,000 by the end of the year, give or take. I want to keep this money relatively available, in case of emergencies or lay offs, and because we don't know if we are going to move spring 2012 or 2013. I also can't risk loosing it, but I'd like to get better than the measly 1% interest a saving account pays. I had invested it in Schwab's "Conservative" mutual fund assortment this past spring, but got cold feet with all the debt ceiling talk and pulled it back out. So where's a safe place I can put this money, where it might earn some fair interest, but still be accessible? Josh, Minneapolis, MN

Answer: Millions and millions of American savers share your frustration (although not all are doing as well as you are at setting money aside). You want your savings to be safe but you'd like your money to earn something. The power of compound interest is pretty feeble at less than a 1% interest rate.

You're losing out to inflation, too. The headline Consumer Price index is at a 3.6% rate over the past 12 months (ending in June). You're even falling behind the so-called core rate of consumer inflation. Many economists argue the core rate--the CPI minus volatile food and energy--is a better gauge of the underlying inflation trend. Well, the core rate of consumer inflation is running at a 1.6% rate--more than the 1% your getting from your savings.

That said, a theme of these Getting Personal posts is that in many cases the risks associated with earning a higher yield aren't worth it when it comes to your safe savings.

Your potential timeline of 2012 or 2013 isn't very long. And while it's true that we're always being battered by uncertainty, the risks of something bad happening in the global economy are especially high right now. Trouble spots include the European sovereign debt crisis, the troublesome negotiations over the debt limit ceiling in Washington D.C., and inflation worries in China.

Even some of the world's greatest investors are retreating toward the safety of cash, according to this Bloomberg Businessweek story.

Keith Anderson, who runs the $25.5 billion Quantum Endowment Fund for Soros Fund Management LLC, has seen enough of choppy global markets.

In mid-June, Anderson told his portfolio managers to pull back on trades as the hedge fund's losses hit 6 percent for the year, according to two people familiar with the New York-based firm. As a result, the fund is about 75 percent in cash as it waits for better opportunities, said the people, who asked not to be identified because the firm is private.

By the way, on Wall Street "cash" isn't the money in your wallet or purse. It's Treasury bills and other high-quality short-term interest paying investments.

Despite fractional rates on savings, I would still embrace a mix of quality short-term investments, such as online savings accounts, T-bills, short-term certificates of deposit, and the like.

You could consider putting some money into the short-term debts of blue chip multinational corporations. These companies are flush with cash. Similarly, you could pick up some extra yield investing in a well diversified high-quality short-term municipal bond fund. The fear of a massive wave of muni bond defaults has been greatly exaggerated, but I would still embrace additional layers of safety through diversification and investment grade debt.

The bottom line: The price of safety is a fractional rate of interest on fixed income investments. I'm okay with the trade-off.

About the author

Chris Farrell is the economics editor of Marketplace Money.

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