CD Switch: Are Short-Term Funds Worth It?

Bank savings are safe but yields are pitifully low, causing many savers to reach for bigger yields in short-term bond funds. But the results are so modest it may not be worth the trouble.

Today, the average savings account pays just 0.195%, and the average money-market account only 0.282%, according to the BankingMyWay survey. That’s about as close to nothing as you can get, especially with inflation taken into account. But at least your principal is safe.

What could you earn in a short-term bond fund? Christine Benz, director of personal finance for Morningstar Inc., the market-data firm, has recommended a few candidates that can pay better than bank savings but still be relatively safe.

Benz suggests investors divide their rainy-day funds in two, putting several months worth of money in real cash such as bank savings, and steering the rest toward short-term bond funds with higher yields.

Unlike long-term bonds, short-term bonds tend to hold their values fairly well when interest rates rise. That’s because investors will get their money back soon, so they won’t suffer below-market yields for very long.

Benz looked for short-term bond funds that have been less risky than their peers. She focused on those with very low fees and no loads, or sales commissions, as any type of charge can seriously undermine yields when interest rates are as low as they are today.

Her search produced three funds: the T. Rowe Price Short-Term Bond Fund (Stock Quote: PRWBX), yielding 2.86%; USAA Tax-Exempt Short-Term Fund (Stock Quote: USSTX), yielding 2.59%; and Vanguard Short-Term Bond Index (Stock Quote: VBISX), yielding 2.28%.

All of those beat bank savings. Even a five-year certificate of deposit averages only 1.779%, according to the BankingMyWay survey.

With a five-year CD you’d lose six to 12 months interest if you took your money out early, while there’d be no early withdrawal penalty for a short-term bond fund.