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Money Market Rates of 5 Percent?

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Some experts interviewed by this Miami Herald article are saying that the average money rates may hit 5 percent by 2006. If the Federal Reserve continues its rate increases over the next year, this could happen. Over the last 14 months, it reported that the yield on the average taxable money fund has gone from about a half a percent to 2.89%.

The article described some of the cash choices for savers. The three main choices include money market mutual funds, money market accounts, and CDs. Unlike the other two, money market mutual funds are not FDIC insured, however, the risk of losing principle is extremely low. Vanguard has some good low cost choices. Their taxable money market funds are currently yielding around 3.2%. Tax free money market mutual funds which invest in municipal bonds may be good choices for high income individuals. Vanguard tax exempt money market is currently yielding 2.42%. That's equal to 3.6% to a taxable fund for someone in the 33% tax bracket.

The article also described the CD as a choice for savers. It's a difficult time to decide on a CD. The top CD rate is currently only between 4 and 5 percent. Even the best CD rate with 5 year terms are lucky to be over 5 percent. With the best money market rates over 3.5% and with talk about 5% rates next year, it's difficult to justify a 5 year CD that may only be paying 4.6%.

However, the decision to stick with money market accounts rather than CDs isn't clear cut. If the Fed stops raising rates by the end of the year, short term rates may not reach above 4%. And the flat yield curve could continue which would mean the highest CD interest rate may not get much above 5%. So it's possible that a 5% CD now may turn out better than a 3.5% money market account with hopes of better rates in the near future. You have to factor in the interest lost during the waiting period. If both short and long term rates do rise over the next year, waiting for a long term CD may be wise. Perhaps next year, we'll see a top CD rate of over 6 percent. But there's no guarantee that's going to happen. Last year, I would have predicted that after 10 Fed rate increases we would be seeing 6% CD rates. This flattening of the yield curve in which short term rates rise while long term rates fall has been puzzling. Greenspan described it as a "conundrum" last February.
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