Even 'Safe Money' Can Be Parked in Short-Term Bonds
Cash really is trash. The average taxable money-market fund yields 0.08 percent. The yield of the average tax-free money fund is 0.12 percent. Even a one-year bank certificate of deposit will, on average, pay you less than 1.8 percent, according to Bankrate.com.</br></br>Once in a while, it pays to take a little risk with your "safe" money -- and this is such a time. I'm not talking about taking money you've put aside to buy a car in six months and dumping it into stocks or a high-yield bond fund. But investing that money carefully in the right short-term, high-quality bond fund -- or maybe even an intermediate-term bond fund -- makes a lot of sense.</br></br>Most investors should start, and probably end, their search for such a fund with Vanguard. The firm generally charges the lowest fees on most types of bond funds, and it is conservative to its core. Its bond managers seek out the highest-quality bonds and don't try to get cute.</br></br>My favorite tax-free money-fund alternative is Vanguard Limited-Term Tax-Exempt. The fund yields 1.7 percent. Last year, when most bonds suffered because of credit-quality concerns and lack of liquidity -- rather than rising interest rates, which generally cause bond prices to fall -- the fund held up marvelously. From Jan. 22 to Oct. 30 of last year, the period of maximum stress, the fund lost a paltry 0.3 percent.</br></br>What if you're in a low tax bracket or you're investing in a tax-deferred account, such as an IRA? Vanguard Short-Term Investment-Grade is your ticket. It yields 3.1 percent. If yields on similar bonds rise by one percentage point, it should lose just 2 percent of its value. Average credit quality is single-A. During last year's bond-market meltdown, this fund, which invests almost entirely in corporate bonds, fell 6.5 percent at its worst.