Suze Orman Money Matters

You don't need a Ph.D. in mathematics to understand that the numbers aren't working in your favor these days. The Fed's aggressive easing of the federal funds rate has made a mess of your cash and fixed-income strategies.

The most aggressive bank savings deals pay out little more than 2.5 percent to 3 percent right now. Given that the official inflation rate is above 4 percent, you're pretty much guaranteed a negative real rate of return. And you're probably feeling a lot more than a 1-percentage-point shortfall; the official Consumer Price Index (CPI) numbers sure don't seem to reflect the much-higher price hikes for basic food and fuel.

Do the Right Thing

That makes it extra hard to do what's right. Amid the economic slowdown, your emergency savings account becomes an important survival tool to protect against the possibility of being laid off or having your hours reduced. Yet it's hard to concede that the money you set aside in a cash account isn't protecting you against inflation, so you do what seems logical: you look for higher-yielding alternatives.

I'm hearing from more and more of you that you're shifting from CDs into 10-year Treasuries, where the yield is about double what your bank might be paying out. Please be careful when extending into longer maturities -- you're exposing yourself to locking in a low rate of return. Given the inflation rate, that's a bad place to be once the tide turns and the Fed starts to tighten.

Will that happen tomorrow? No. But it sure looks like it'll happen sooner rather than later, if you believe that the anemic dollar and rising inflation will need to be addressed. It's pretty obvious that there isn't much more room for further Fed easing; maybe another .50 basis points, but that should be that.

So now is the time to cautiously navigate the world of fixed income and yield to the desire to extend into longer maturities. Here are four key things to remember when you do:

• Keep your savings safe.

The point of your emergency cash fund is to protect you. Ideally, you don't lose out to inflation in the process, but I think the need for safety outweighs the desire to earn more in riskier investments.

The bottom line is that your eight-month emergency cash fund belongs in, well, cash. Nothing more. You don't put this money at principal risk.

That said, you want to make sure you're earning the highest possible "safe" return, so that means shopping for the best bank deal. The online banks EmigrantDirect and ING Direct continue to offer competitive deals. You might also check out iGObanking.com; it recently offered a 3.28 percent payout on its savings account.

• Don't get into a fixed-income fix.

I've always been a big believer in the laddering strategy for the fixed-income portion of your portfolio. Currently, I would own a mix of short- and medium-term maturity bonds to best address the risk/reward challenge. You get a higher yield than you would with a 100 percent short-term portfolio with lower risk than a 100 percent long-term portfolio.

But what I'm hearing from many people right now is that they're shifting out of the short-term positions and adding to their long-term holdings. Again, I think that's playing with fire. I'm not suggesting that the Fed's going to start tightening in the next month or two, but you have to believe that with continued inflation pressure tightening is on the horizon, and that's not going to bode well for those purchasing long-term bonds right now.

So stick with a laddered approach. Also, if inflation is a concern for you, and I think it should be, you should consider changing the type of bonds you own. Instead of straight Treasuries consider Treasury inflation-protected securities (TIPS). The interest rate is fixed on TIPS, but your principal is adjusted every six months in line with changes in the CPI. If inflation rises, so does your principal. That means you pocket a higher interest payout as you earn interest on your higher principal. You can buy TIPS in increments of $1,000 from TreasuryDirect.

• Check out munis.

While TIPS offer a decent inflation hedge, the fact is that anxiety over the credit crisis fallout has boosted demand (bond prices) so much that TIPS yields have been pushed lower. They're still attractive, just not as good-looking as a few months ago.

Interestingly, the same credit-crunch fears have created an investing opportunity in tax-exempt bonds. Yields remain high in part due to the flight to Treasuries and lingering concerns about the bond insurance market. If you stick with highly rated bonds, the risk remains quite low and the yield can't be beat.

The average yield for five-year AAA muni bonds was recently 3.1 percent. That's more than the 2.9 percent payout on a regular 5-year Treasury. And let's remember that Treasury income is taxed at the federal level, while munis, of course, are tax-free. So for someone in the 28 percent federal tax bracket, the 3.1 percent muni yield is the equivalent of a taxable 4.3 percent. If you're also subject to state and local income tax, munis look even better.

• Lock in high yield return elsewhere in balance sheet.

Many of you are so focused on how to wring out an extra half-percentage point on your cash and fixed income that you're overlooking the potential for big risk-free returns lurking on the debit side of your financial statement.

Once you build a sufficient cash stash, don't unnecessarily hoard more dollars in it. As adamant as I am about the need for an emergency cash fund, in this low-rate environment it makes sense to only keep the minimum in cash. Once you have your eight-month to one-year cushion, use your extra dollars to pay off any higher-rate debt.

Credit card debt is a no-brainer. In fact, if you're dealing with high-rate card debt of 18 percent to 20 percent or more, I would even suggest you dip into your emergency cash position (I know I'm making an assumption you have one) to get the balance paid off. When you have high-rate card debt, the "security" of a large emergency cash fund is a bit illusory; you won't have complete security until you pare down that costly debt.

Your car loan is more debt to tackle. And for those of you who intend to stay put in your home, I recommend using any extra cash to speed up your principal payments. Taking money out of a 2 percent to 3 percent taxable cash account to pay off a 6 percent mortgage can make a lot of sense. The end result is that you'll own your home outright a lot faster -- and that's just the sort of security that makes sense in any market environment, but especially this one