The Error-Proof Portfolio: Seeking a Safe Return on Your Cash? It's Time to Get Creative

Savers, I've got bad news: It looks like we might be stuck here awhile.

By "stuck here," I mean that those looking for a decent (is positive too much to ask?) risk-free return on their dough are going to have to be patient. The Federal Reserve had already signaled that it was inclined to keep the federal-funds rate "exceptionally low" through late 2014, and recent indications of slower economic growth across the globe make a continuation of that accommodative stance look even more likely.

The zero-interest-rate policy is designed, at least in part, to get investors out there taking some risks, and many have clearly taken the Fed's cue. The stampede into bond funds may indeed be driven by demographic trends, as baby boomers need to lighten their equity stakes in anticipation of retirement. But an untold story of the assets flowing into bonds is that yield-starved investors are fed up with the rock-bottom yields on money market funds and certificates of deposit so they're taking on interest-rate and credit-quality risk instead.

Bonds deliver a yield pickup versus cash, of course, but you also pick up something less desirable: the risk of principal fluctuations. Those who have ventured into credit-sensitive bond-fund categories in search of a bit of extra yield have recently observed that risk firsthand, as bank-loan and high-yield funds have slumped along with the equity markets. Meanwhile, taking on extra interest-rate sensitivity could backfire if the economy shows unexpected signs of picking up steam, thereby causing interest rates to go back up. The message is clear: When it comes to money you can't afford to lose, there's no substitute for true cash: CDs, money market accounts, and so forth, minuscule yields and all.

What's a well-meaning investor looking for a safe return to do? Given that the real yields on true cash instruments are negative right now, that argues for keeping your cash holdings to a minimum--enough to serve as your emergency fund if you're still working or to provide for one to two years' worth of living expenses if you're retired. At the same time, it's sensible to keep your eyes open to other ways to earn a positive risk-free return on your money, beyond just stashing it in the bank. Although not all of the following alternatives will provide you with the same liquidity you'll get with cash holdings, they will provide you with a safe return that's both guaranteed and likely higher than what your cash is earning.

Here's a short list of some ideas; if you have additional ideas to share with other Morningstar.com readers, please use the comments field below this article.

1. Send a little extra to your lender.
Financially savvy folks well know the value of not carrying around high interest-rate debt, but they may not see paying off their mortgages as a priority. After all, mortgage rates are ultralow relative to historic norms, and you might be earning a deduction on your interest. But if you're looking for a guaranteed return on your money of 3%, 4%, 5%, or more, you owe it to yourself to pay more on your mortgage than your lender requires. You won't owe additional interest on any amount of your mortgage principal that you can prepay, and you'll also shorten the length of your loan term by paying extra on your mortgage on a regular basis. Of course, once that money is sunk into your principal, you'll have to jump through hoops and pay interest to get it back out (via a home equity loan), so this strategy isn't for people who don't have an adequate cash fund on hand already.

In a related vein, you can also shave your lending costs by taking advantage of today's ultralow rates. Even if you refinanced as recently as a year ago, it might pay to do so again. Rates on 30-year fixed mortgages were recently hovering around 3.75%, while those who can swing a 15-year loan might be able to bring their borrowing costs close to or even lower than 3%.

2. Investigate cash-back credit cards.
No-fee cash-back credit cards provide another way to pick up a risk-free rate of return, typically rebating you a percentage of each of your purchases. Such cards often pay a higher percentage for everyday expenditures like food and gas than they do for other purchases, and some cards will pay you a higher rate for certain categories of expenditures or purchases with specific retailers. Like the previous strategy, this one doesn't give you liquidity as true cash does. Moreover, this strategy is obviously only for disciplined credit card users who never carry a balance, as the cards often charge higher interest rates on balances than non-cash-back cards.

3. Consider credit unions.
Interest rates on savings vehicles offered through credit unions are often a bit higher than what's available through traditional banks and asset-management firms for a few reasons. First, credit unions are owned and controlled by their members, so they don't have to deliver a slice of profit to their shareholders like banks do; more money can flow through to savers. Credit unions can also pay higher rates of interest than banks because they don't market their services or typically invest as much in physical branches as commercial banks do. That said, yields on credit union savings vehicles have dropped right along with everything else in recent years, so prospective investors should check their expectations. My recent survey of savings accounts available through credit unions showed rates in the 0.70% to 0.80% range--higher than the typical money market fund but with a similar level of liquidity.

In a related vein, health savings accounts held with credit unions might offer even higher interest rates--well more than 1%. That, as well as the opportunity to make tax-advantaged contributions and tax-free qualified withdrawals, provides yet another reason to consider using a health savings account in conjunction with a high-deductible health-care plan. This article provides details on HSAs; be sure to read the many valuable user comments below the article.

4. Look inside your 401(k).
A company retirement plan isn't usually a first choice for liquid securities: Unless you're retired, you won't have ready access to your cash, and in any case, accumulators will generally want to hold long-term securities, especially stocks, in their 401(k)s. That said, company retirement plans may also hold higher-yielding safe options than are available via other avenues, so if cash is part of your asset-allocation framework, consider obtaining at least part of that exposure via your plan. Stable-value funds, which typically appear in 401(k)s, offer higher yields than money market funds; while investors' principal isn't guaranteed, a series of insurance wrappers helps shield holders from principal fluctuations.

U.S. government employees also have a compelling, unique cashlike option in the Thrift Savings Plan, the retirement savings plan for government workers. The G fund offers a yield in line with intermediate-term Treasuries with principal guarantees--a rare combination indeed. This article discusses the TSP in depth.

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