Selecting The Right Savings Vehicle
For Your Time Horizon

It makes sense that money set aside for emergencies would be saved in a different type of account than money being accumulated for a major purchase years down the road. Yet that simple principle—different savings vehicles for different needs—is routinely ignored. Many savers, either through ignorance or inertia, let their savings dollars languish in low-yield savings or no-yield checking accounts. We suggest you consider the following choices instead.

• Money Market Funds. A good MMF is a solid choice for an "emergency fund"—i.e., money that might be needed at any moment. MMFs provide instant liquidity through check-writing privileges, and are virtually as safe as bank money market accounts (MMAs). Historically, MMFs have yielded 1.0%-1.5% more than MMAs, although that hasn't always been the case recently. (For more information, see Why You Usually Get Your Best Savings Deals from Money Funds and Getting Your Money's Worth. )

• Money Market Accounts. MMAs also work well for an emergency fund, and have the advantage of being insured by the FDIC. MMA rates have been unusually competitive with MMFs the past few years, as interest rates have been near historic lows. The best MMAs currently offer comparable yields to MMFs. These are usually available through online banks, several of which are listed in our Best Rates tables . Online MMAs let you create an electronic "link" to your regular checking account, giving you virtually instant access to your MMA savings in an emergency.

• Certificates of Deposit (CDs). CDs require you to commit your money for a term of one month to five years. The longer the period you're willing to commit to, the higher the interest rate you'll receive—although right now the spread between shorter- and longer-term rates is quite narrow. CDs carry penalties for early withdrawal, so they're best used for funds you're confident you won't need until a specified future date. (For more information, see Using Bank Certificates of Deposit to Build a Savings Ladder.)

• Ultra Short-Term Bond Funds. These funds represent the next rung up the risk ladder from the first three options. That's because the rate of return you'll receive is uncertain when you invest, and you could even end up losing a little money (that's happened with some ultra-short funds lately). If you need to be certain you'll have a specific dollar amount on a given date, CDs are the better choice. But if you're willing to allow a small level of variability, ultra short-term bond funds will usually produce a better return over holding periods of 6-12 months. (For more information, see SMI Changes Stance Towards Ultra Short-Term Bond Funds .)

• Short-Term Bond Funds. If your savings won't be needed for two-to-three years, step up to a short-term bond fund. Bonds with longer maturities pay higher yields, which is how these funds produce higher returns. The downside: the prices of bonds owned by these funds can fall when interest rates rise. That makes them a somewhat risky proposition for savers with time frames of less than two years. If your savings goal is at least that far away, however, the higher yields of short-term bonds usually compensate for any near-term losses created by rising rates. (For more information, see For Savings You Won't Need to Draw On for Two to Three Years. )

• Mortgage-Backed Bond Funds. These funds, often referred to as GNMA (Ginnie Mae) funds, invest in mortgage-backed securities issued by the Government National Mortgage Association. Ginnie Maes are even more sensitive to interest rate changes than short-term bonds and can definitely lose money in the near-term, so a longer holding period is critical. Historically the higher yields of these bonds have eventually more than compensated for any short-term losses caused by rising interest rates. This can take time though, so only choose them if your holding period is at least three years. (For more information, see Why Mortgage-Backed Bond Funds Make Sense for Long-Term Savers. )

With the overall direction of interest rates being uncertain right now (the Fed, after two years of steady hikes and one year of holding them steady, recently cut short-term interest rates), it's difficult to predict which vehicles will be the most advantageous going forward. If rates rise, MMFs and MMAs will immediately take advantage of those higher rates. If rates decline, short-term and mortgage-backed bonds are more likely to benefit while MMFs and MMAs will suffer. CDs will lock you in at today's rates—good if rates fall, not so good if rates rise.

Rather than choosing a savings vehicle based on interest rate expectations, which are notoriously difficult to predict, it's better to base your decision on the time frame until you need the money. If you might need the money right away, keep it in an MMF or MMA. If you won't need it for a couple of years, a short-term bond fund might be the best choice. For even longer time frames, consider mortgage-backed funds. As with most investment decisions, thinking inside-out will usually provide better results than basing your decision on external factors like the direction of interest rates. For more on this, see Make Sure Your Investment Decision-Making Is Inside-Out.

• Current Best Rates tables 
• SMI Savings Accounts page
• Why You Usually Get Your Best Savings Deals from Money Funds
• Getting Your Money's Worth 
• Using Bank Certificates of Deposit to Build a Savings Ladder
• Ultra-Short Term Bonds Take A Hit: Time to Run for the Exit? 
• For Savings You Won't Need to Draw On for Two to Three Years 
• Why Mortgage-Backed Bond Funds Make Sense for Long-Term Savers 

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