You could put the money in a savings account and earn virtually nothing. You could put it in a money market fund and suffer the same fate. You could select a short-term bond fund, but you will get little more than you earn in a savings account, and your risk of losing some money will be greater when interest rates start climbing.
Short-term bond funds have typically been popular with financial advisers trying to earn a little more yield for individuals.
Yet, Morningstar analyst
In the current environment of low interest, your best deal would be five-year bank CDs, provided you are willing to skip your local bank and head to an online source such as Bankrate.com to scout for palatable interest rates. Last week, the site had identified a couple of banks offering 2.27 percent on five-year CDs:
Lee's conclusion is an unusual one for an analyst who makes a living examining exchange-traded funds. But as he looked at 31 short-term bond-traded funds, he concluded they would pose more risk than the CDs, and not pay interest as high. CDs from banks typically are
As for CDs, pay attention to the penalties. Lee found
Note that the penalties are capped. You know from the start what will happen if you get antsy about pulling money out early.
That's not the case with bond funds; including short-term bond funds.
There is no cap on what you can lose, and the loss will happen if interest rates are climbing when you need to withdraw your money.
"If interest rates spike 10 percent overnight, you'd be hit with double-digit losses on all but the shortest-duration bonds, but your CDs will lose almost nothing, and you'll have the option to reinvest at these higher rates," Lee said.
Lee makes a point of suggesting bank CDs, not brokered CDs like you get from a brokerage firm or adviser.
The brokered CDs don't provide the leeway the that bank CDs do with modest penalties. And there are also fees on the brokered version.
"There is no better deal out there" in bonds, Lee said in a Morningstar report. If bond fund operators "
Further, if you wanted a 2.25 percent yield on a U.S. Treasury bond, you would have to buy one that wouldn't mature any earlier than seven years.
Seven years is a long time to lock up money if interest rates and inflation start climbing, and selling a 7-year bond during rising rates will give you a loss.
Corporate bonds are no competition for the safe CDs either, Lee said. Corporate bonds can become losers when the economy or the corporation weaken.
High-yield bonds and bank loans are even more vulnerable in weakening economies.
"I suspect most investors could improve their portfolios by dumping their bond funds for CDs and using their freed-up risk capacity to buy foreign equities, which I believe offer a better risk-reward trade-off than most bonds," Lee said in a report.
Of course, stocks are not the right choice for people who are saving cash for a purchase or living expenses that must be paid over the next five years.
But if you are saving for many years ahead and have been hoarding cash simply because you are nervous, putting some money in stocks makes sense.
Ultimately, they should provide better returns than the 2.25 percent on CDs.
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