Where to stash your cash

Even with banks failing and scandals hitting once-safe investments, there still are a few ways to protect your money.

By Mina Kimes, reporter

NEW YORK (Fortune) -- Now that even the biggest banks are battling for survival, traditionally safe investments suddenly look fallible.

What happens to your money market account if your bank fails? Or even worse, if you buy a CD from someone like Stanford Financial, the bank that lured investors with above-average yields and allegedly funneled their money into a Ponzi scheme?

There's no need to panic: certificates of deposit and money funds are generally still safe places to stow your cash - even if they're a bit less lucrative than they used to be. But many of their issuers do face the possibility of going under, which is why you should investigate their fundamentals, not just their yields.

The easiest way to avoid a bank like Stanford Financial, says Greg McBride, senior financial analyst at bankrate.com, is to ask first whether a CD is FDIC-backed. Stanford's were not.

"Just because something's called a CD doesn't necessarily mean it's insured," he says. The FDIC coverage limit is $250,000, but investors can spread out protection by buying CDs at different banks.

Once you establish that a CD is insured and doesn't come with excessive penalties for early withdrawals, then you can comparison shop for yields. But keep in mind that high yields are like retail sales promotions - they may signify desperation. The top-yielding one-year CD on bankrate.com is issued by GMAC Bank, part of the struggling financing arm of automaker GM.

Many of the high-yielding CDs listed online come from lesser known issuers like Web-based brokers or regional banks. That doesn't necessarily mean that they're untrustworthy (even blue-chip banks are on shaky ground), but you should make sure that they're stable.

Even if a CD is FDIC-backed, its yield could change if its issuer goes bankrupt or gets bought. "When a merger occurs, the acquirer has the option of honoring the yields on the deposits," says McBride. Wells Fargo may have maintained the yields on the CDs it picked up when it bought Wachovia, but not all banks will do so.

With all those caveats, CDs still offer superior returns to most other secure investments. The highest yielding one-year CDs on bankrate.com - all of which are FDIC-backed - offer yields between 2% and 3%. While that's less than what it was last summer, it's still much higher than the 0.7% yields on one-year Treasurys.

Don Humphreys, president of Voyager Wealth Management, says his clients are clamoring for CDs. "The rates are relatively good for what you're getting," he says. Because inflation has decreased alongside yields, the real rate of return on CDs is actually better than what it was last year.

Liquid but less lucrative

If you want the option of withdrawing cash at any time, an alternative to a CD is a money market fund, which is a mutual fund that invests in safe assets like commercial paper and Treasurys. Because the rates on their underlying investments have plunged in recent months, fund yields have dropped to record lows.

"We've reached the point where 1% is a high yield," says Peter Crane, the president of money market research firm Crane Data. The yield on the largest money market fund, Fidelity Cash Reserves, recently dropped below 1% for the first time.

Unlike CDs, money market funds' yields fluctuate regularly. Humphreys says the current lows make them options of the last resort. "If you have money that can be locked up for a short term, I'd definitely recommend a CD," he says. "Even the money funds that invest in riskier assets aren't offering aggressive yields."

Money fund managers have waived fees in an attempt to keep yields above zero, but several funds have already closed or merged, and Crane predicts a continued wave of consolidation. When that happens, deposits are merged into a different fund - or simply sent back to investors.

While the funds themselves aren't FDIC-insured, the Treasury implemented a program in September that guaranteed their assets at the time. That program expires in April, but it's likely to be extended, says Crane.

"The government isn't going to let another money fund break the buck," he says, referring to the massive run on the Reserve Primary fund that precipitated the program's creation.

Still, Crane advises investors to avoid the highest yielding money market funds and opt for the third or fourth best yielding investments instead.

"In general, the highest yielding fund attracts the wrong crowd - people who take out their assets the second the yield is no longer number one, causing a run, which is what happened at the Reserve," he says. The lure of an extra tenth of a percentage point isn't worth the risk.

Investors who are willing to sacrifice some liquidity but still want the option of withdrawing money without penalties have a third option, which is a money market deposit account. These are essentially bank savings accounts that allow for limited withdrawals.

From a risk standpoint, money market deposit accounts are like CDs - they're FDIC-insured for up to $100,000 for individual accounts and $250,000 for retirement accounts. But unlike CDs, the yields aren't locked in.

"The yields on money market deposit accounts are a good deal better than those of money funds," says McBride. "But that yield can change any time." Crane thinks current yields, which are topping out at 2%, will drop closer to those of money funds soon.

But with all cash investments offering relatively low yields, the promise of safety may be alluring enough, says McBride.

"Right now, investors are more concerned with return of principal than return on principal," he says. To top of page

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