Money being set aside for a major purchase two or three years from now should be saved in a different type of account than money that might be needed right away for a financial emergency. Unfortunately, that simple principle — different savings vehicles for differing needs — is routinely ignored. Indeed, many savers allow all of their savings to languish in low-yield local-bank savings accounts instead of choosing better options.

Below is a list of better savings vehicles, starting with the best places for emergency savings.

Money-Market Accounts. Liquidity and safety are the two key elements of an emergency fund, and bank MMAs offer both. MMAs, which are insured by the FDIC, pay higher rates than regular bank savings accounts — and higher still if you set up your account with an online bank. An electronic "link" between an online MMA and your regular checking account will provide virtually instant access to your savings in an emergency.

Money-Market Funds. Historically, MMFs — a type of mutual fund — have had a 1.0%-1.5% rate advantage over MMAs. Not now. So until rates start going higher, there's no reason to put your emergency funds in an uninsured MMF when an insured MMA offers a better yield.

Certificates of Deposit (CDs). CDs require you to commit your money for a period of anywhere from one month up to five years. The longer the term, the higher the rate of interest you'll receive — but if market rates rise, you will have tied up your money at below-market rates. CDs also carry penalties (forfeited interest) if you take your money out early.

Short-Term Bond Funds. If you won't need your savings for 2-3 years, consider a short-term bond fund. The bonds held by such funds offer higher yields than shorter-term instruments.

But there's a downside: if interest rates rise, the value of the bonds held in these funds will fall (interest rates and bond prices move in opposite directions). That makes short-term bond funds a bit risky for savers with time horizons of less than two years. However, if your savings goal is at least that far away, the higher yields of short-term bonds are likely to eventually compensate for any near-term losses.

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 are short-term bonds, so a longer holding period is crucial. We suggest a minimum of three years for these funds. In the past, the higher yields of Ginnie Maes have more than compensated (eventually) for short-term losses caused by rising interest rates.

LOOKING AHEAD

The Federal Reserve says interest rates will stay low for an "extended" period, but no one knows what that means. So rather than choosing a savings vehicle based on interest-rate expectations, base your decision on the time until the money is needed. For funds you may need at any moment, go with a bank money-market account. If you won't need certain savings for two years or more, short-term bond funds are likely to be the optimum choice. For longer time frames, go with a mortgage-backed bond fund.

As with most investment decisions, thinking inside-out is likely to provide better results than basing choices on external factors such as rate expectations.

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