Better Than A Money Market

In today's turbulent market environment, many risk-adverse investors have wisely moved into cash, parking their money in money market accounts. Currently, money markets are paying two to three percent on average, but might there not be other investment vehicles that pay more while still being low-risk? The answer, of course, is yes. (If the answer was no I wouldn't have an article.)

So, what are these investment vehicles? They're are old friends, the exchange-traded funds (ETFs). If you don't know what an ETF is, it's a mutual fund that trades on the American stock exchange (AMEX) just like a stock. That means that you can buy them at any time during market hours unlike a mutual fund which only trades at the end of the day. ETFs are linked to an index which means that they are passively managed (although the underlying index might not be) which keeps expense ratios low, much lower than their mutual fund counterparts.

The past several years has seen an explosion in the ETF universe. If there's an index out there, there's probably an ETF that tracks it. The largest fund issuers are PowerShares, Vanguard, State Street Global Advisors, and Barclays. For income investors as well as the gun-shy investor, here's a list of ETFs that are relatively risk-free and pay higher returns than a money market. The good news, too, is that some of them are completely tax-free or are taxed at lower rates.

1. State Street's Lehman Muni-Bond (TFI): Tracks the Lehman Brothers municipal bond index.
Current NAV (net asset value): $22
Current Yield: 4.52%
Tax-equivalent Yield: 6.05%
Expense Ratio: 0.2%

2. PowerShares Insured California Muni-Bond (PWZ): Based on the Merrill Lynch California Insured Long-Term Core Municipal Securities Index, which is designed to track the performance of AAA-rated, insured, tax-exempt, long-term debt publicly issued by California or Puerto Rico or their political subdivisions. (Puerto Rico is tax-free for all states.)
Current NAV: $24
Current Yield: 4.21%
Expense Ratio: 0.28%

3. PowerShares Insured New York Municipal Bond (PZT): Based on the Merrill Lynch New York Insured Long-Term Core Municipal Securities Index, which is designed to track the performance of AAA-rated, insured, tax-exempt, long-term debt publicly issued by New York or Puerto Rico or their political subdivisions.
Current NAV: $24
Current Yield: 4.17%
Expense Ratio: 0.28%

4. PowerShares Insured National Municipal Bond Portfolio (PZA): Based on the Merrill Lynch National Insured Long-Term Core Municipal Securities Index, which is designed to track the performance of AAA-rated, insured, taxexempt, long-term debt publicly issued by U.S. states or their political subdivisions. This fund can be considered safer than the TFI since all of the bonds here must be insured compared with only 46% in the other.)
Current NAV: $24
Current Yield: 4.19%
Expense Ratio: 0.28%

5. PowerShares Emerging Markets Sovereign Debt (PCY): Based on the Deutsche Bank Emerging Market U.S. Dollar Balanced Liquid Index, an innovative index developed by Deutsche Bank Securities Inc. that provides intelligent access to the sovereign debt of approximately 17 emerging market countries. Although you may think this portfolio is high-risk, it's not because it invests in sovereign debt as opposed to corporate debt making it much lower risk.
Current NAV: $26
Current Yield: 5.59%
Net Expense Ratio: 0.50% (This is the highest expense ratio of the bunch, but note that it's the same as the Lehman International Treasury Bond ETF.)

This is a sampling of some of the ETFs that you can substitute for a money market. Although you don't have some of the conveniences that a money market offers, like writing checks for example, you do have the ability to liquidate your positions easily if you do need some cash.* And compared with mutual funds that can require several thousand dollars to buy their product, there's no required minimum investment.

So when's the best time to buy these products? Well, when the net asset value (NAV) is low. Duh. All of these ETFs hit their historic lows on February 29th and have been recovering since then. If any of these products interest you, now would be a good time to buy. Although it may seem counterintuitive, the Emerging Markets ETF, the PCY, has been the least volatile of the bunch, trading in a very tight range between $25 and $26. It also adds a bit of diversity to the above products as the international market is less tied to the US market (less correlation).

Now you don't have any excuse to keep all of your cash tied up in a low-paying money market!

*A note on trading liquidity: Some ETFs, notably the PWZ and the PZT, have low trading volumes (<10,000 shares per day) but please don't confuse low volume with liquidity. ETFs are open-ended investments as compared with closed-end funds. A closed-end fund can suffer dramatic changes in their NAVs if there is a spike in trading volume, but not ETFs since new shares can always be created. This maintains the stability of the NAV which in essence should reflect the value of the portfolio's holdings. Moral of the story: Don't be afraid to buy into an ETF that trades on low volume.