How Ultra-Short Term Bonds Can Help
Boost an Emergency Fund

The key characteristic of an emergency fund investment is liquidity—the ability to easily and quickly convert it to cash. That's why money market mutual funds are usually the best place to store your emergency savings. However, if you're not content with the returns in your emergency fund, there are ways to boost your returns without adding much risk.

One option is to start by treating a portion of your emergency fund more like an accumulation fund. In an accumulation fund (where you're saving up to make a major purchase), your longer time frame of one to five years allows you to improve your returns by taking a step up the risk ladder to short-term bond funds.

Bond funds in the ultra-short term category typically have such low volatility that many consider them reasonable substitutes for money market funds in certain situations (although, unlike money market funds, the daily value of your shares will fluctuate slightly). The portfolios of these funds cover a wide range of bonds, including Treasuries, mortgage-backed, and various grades of corporates. The theory is that, under most market conditions, the diversification combined with very short maturities will more than compensate for any quality concessions. If all goes well, shareholders will receive returns that are superior to money funds while taking little additional risk.

In the table at the right we compare the returns of the Schwab YieldPlus (SWYPX) ultra-short bond fund to those of the consistently excellent Vanguard Prime Money Market Fund. Occasionally, the Schwab fund might briefly trail its money market competitor—either when the more risky portions of their portfolios are hurt by economic recession or when rising interest rates take a bite out of bond fund holdings. But these times have been rare. You can see that the Schwab fund has outperformed Vanguard Prime for five straight years going back to 2001, and is on pace to beat it again in 2006.

Schwab YieldPlus does represent a slightly higher-risk holding than Vanguard Prime. While it invests at least 75% of its assets in investment-grade (very high quality) debt securities, the key to its long-term performance has been its managers' ability to successfully navigate the lower quality high-yield segment of the bond market where it's allowed to invest up to 25% of its assets.

This isn't to say you should take all of your emergency fund savings and abandon the liquidity of money market funds. But it seems reasonable to estimate what your likely biggest immediate cash need would be, leave that "liquidity portion" of your emergency fund in a money market fund (or bank savings account), and move the rest into Schwab YieldPlus.

When opening an account for Schwab YieldPlus, you can choose to add check writing privileges by selecting the "request for checks" box on the application. Note that accessing your money is a two step process. First, you'll need to move money from your fund into a sweep account (which can be done online or over the phone). The sweep account is an interest-earning Schwab money market account. You can write an unlimited number of checks for any dollar amount, providing you have money in the sweep account to cover the checks. From the sweep account you can write checks. Purchase and contact information is available in the Current Best Rates tables .

• Current Best Rates tables 
• How Much Emergency Savings Do You Really Need?
• For Savings You Won't Need to Draw On for Two Years or More 
• Why Mortgage-Backed Bond Funds Make Sense for Long-Term Savers 
• SMI's Savings Accounts page

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