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YOUR MONEY: Savings options: Lower returns are OK

The rate on my online savings account is as low as the temperature in Minneapolis. OK, that's an exaggeration. But when the Federal Reserve dropped its key interest rate to near zero last month in an attempt to restart the economy, my online savi...

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The rate on my online savings account is as low as the temperature in Minneapolis. OK, that's an exaggeration. But when the Federal Reserve dropped its key interest rate to near zero last month in an attempt to restart the economy, my online savings account followed suit and dropped its rate for the sixth time in 2008.

There is little reward for saving money these days. Yet in this recession, Americans are stashing away more cash than they have in years. The quick-and-dirty U.S. Bureau of Labor Statistics savings rate, which measures the amount of money left over after monthly obligations, has climbed out of the red and into the black; it sat at 2.8 percent in November. Some economists expect that number to double by year's end.

If you're one of the many Americans realizing that having a cash cushion is critical, your rate of return should not be your top priority. With short-term cash, it's about "return of principal, not return on principal," said Jonathan Scharlau, a chartered financial analyst with SilverOak Wealth Management in Minneapolis.

"What we're telling our clients right now is to basically accept lower yields," he said.

That could be a tough sell for retirees relying on interest to pay the heating bill. But if you're looking for a place to stick your emergency fund, "the only thing that's safe as cash right now is Treasuries," he said. Scharlau advises investors to avoid Treasuries with durations of more than three years "because there's a bubble in intermediate and long-term Treasuries."

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Financial Planning Association of Minnesota members Michael Arnold of Plymouth-based Retirement Planning Navigators and Lucas Bucl of Accredited Investors in Edina are opting for online savings accounts from institutions such as ING Direct, HSBC or Emigrant Direct.

"We are not buying Treasuries or CDs because yields are low, and we don't think the spread from money market funds is high enough to justify the reduced liquidity," Bucl wrote in an e-mail. With rates around 2.5 percent, FDIC insurance of as much as $250,000 per person per bank, and no strings attached, both say, such online accounts are very attractive.

Folks who want to keep their money closer to home might consider a community bank or credit union. Years of rate data from the National Credit Union Administration show that credit unions on average pay more than banks do on CDs and money market accounts. Community banks typically pay more than big financial conglomerates. Not only that, but keeping your deposit in a neighborhood institution allows the corner bank to lend to businesses in your own back yard, "promoting economic growth in your market," Marshall MacKay, president and CEO of the Independent Community Bankers of Minnesota, said.

Although deflation is back on the radar screen, some experts are still suggesting TIPS, or Treasury Inflation Protected Securities. These are government bonds that protect against inflation.

Both PIMCO's Bill Gross and Yale University endowment manager David Swensen have recently professed their love of TIPS, which can be purchased directly from the government in $100 increments through www.treasurydirect.gov .

What about money market mutual funds?

"A regular prime money fund provides the best return for cash assets that will allow you to have overnight liquidity, but there is a risk that the fund has issues," said Jamie Jackson, a portfolio manager at Ameriprise Financial subsidiary RiverSource Investments.

The usually mundane money market fund saw its share of turmoil in 2008. The Reserve Primary Fund saw its shares fall below $1 in September. It is now involved in several lawsuits and it is being accused of fraud by the Massachusetts securities regulator.

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Last year, a handful of financial companies had to put up money to support their own money market fund to avoid "breaking the buck." And returns are so low these days that fees can exceed the yield. A final wrinkle to mention is that funds could halt redemptions if necessary. So much for liquidity.

None of this stopped investors who gave up on stocks late last year from flocking to money market funds in recent weeks. Assets in money market funds continue to climb, increasing by $54.67 billion to $3.895 trillion for the reporting period ending Jan. 7, according to data from the Investment Company Institute.

If you want to join the pack, Jackson suggests that investors look at the quality of the issuer, although frankly I think that's nearly impossible to gauge these days. The Treasury Department's temporary guaranty program is more limited than you'd think, although Peter Crane, president of money market fund tracking company Crane Data, thinks the government would step in to protect investors in the rare event another fund breaks the buck.

No matter what short-term cash vehicle you're considering, think about convenience in addition to yield, said Crane. Is it worth going across town or putting up with another username and password for a few basis points? I also like Crane's so-called wildebeest strategy - "stay in the middle of the pack" when it comes to yields. You have to wonder why one company can offer so much more on a safe investment than the market, he said. Three good sites for comparing rates: www.bankrate.com , ww.cranedata.us, and imoneynet.com.

(Kara McGuire writes about personal finance. Write to her at kara@startribune.com or at the Star Tribune, 425 Portland Ave., Minneapolis, MN 55488.)

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