I'm saving for a home-improvement project. Where can I get the best short-term rates?

These days, finding a decent yield on a short-term investment isn't easy. In fact, depending on how you define "decent," it could be downright impossible.

How does 2% sound? With interest rates so low, that's probably the best you can hope for while still keeping your principal safe. Then again, 2% is better than nothing.

First, let's review your savings options. When it comes to very short-term investments, your main choices are certificates of deposit (CDs), short-term bonds (held individually or in mutual funds), money-market mutual funds and money-market savings accounts. (Note the difference: Money-market savings accounts are government-insured bank deposits, while money-market mutual funds are a collection of short-term debt securities held by a mutual fund.)

Right now, we think the best bet for someone in your situation is a money-market savings account. Why? These accounts offer flexibility, low fees (if any at all) and higher yields than some of the alternatives.

As of July 3, money-market savings accounts had an average annualized yield of 1.36%, according to Bankrate.com. The average money-market fund, on the other hand, had an annualized yield of just 0.58% as of July 1, 2003, according to iMoneyNet.com, a money-market mutual-fund industry tracker. Part of the discrepancy owes to the fact that the Federal Reserve's latest quarter-percentage-point cut in the federal-funds rate hasn't yet been reflected in money-market savings account rates — a process that will unfold over the next few weeks, says Peter Crane, vice president and managing editor of iMoneyNet's Money Fund Report. Nevertheless, once both types of accounts have reflected the latest rate cut, money-market savings accounts will still come out ahead.

Money-market savings accounts also have an additional edge in that many of them don't charge annual fees. Money-market funds, on the other hand, typically come with annual fees and other expenses that in some cases outweigh the interest accruals, says Marilyn Bergen, certified financial planner and co-owner of CMC Advisors in Portland, Ore.

What about CDs and short-term bond funds? CDs aren't fluid accounts that allow you to make contributions and withdrawals whenever you like. Instead, they lock up a specific amount of money for a specific amount of time. So they don't make much sense for those looking to set aside some cash each month. Short-term bond funds, meanwhile, come with the risk (albeit small) of losing some principal if short-term interest rates spike in the next few months. Also, like money-market mutual funds, short-term bond funds come with fees and expenses that cut into their yields. (That said, their yields are higher than most money-market savings accounts. So if you do decide to go this route, look for a low-fee offering, like the Vanguard Short Term Bond Index (VBISX), which has a total year-to-date return of 2.97% and an expense ratio of 0.21.)

Right now, the most competitive banks are offering rates of 2% or more on their money market savings accounts. "Nothing can beat (those banks) right now," says CFP Karl Romero of LPL Financial Services in Santa Ana, Calif. "With anything else, you're going to have some risk."

Just be warned: These rates are offered by Internet banks, which might not be everyone's first choice when it comes to banking. These banks can afford to pay higher yields because they don't have the overhead expenses of managing brick-and-mortar branches across the country. Of course, this also means they don't have ATMs for taking customer deposits or making withdrawals (although some will reimburse customers for a limited number of withdrawals from other banks' ATMs). Instead, all transactions take place between the bank that holds the customer's checking account and the one that manages the money-market account. The customer authorizes the desired transfer online, over the phone or by mail. Like traditional banks, most Internet banks don't offer check-writing privileges for their money-market savings accounts. They also typically limit customers to six transactions a month.

Which banks offer the best deals? You can get 2.22% with the Bank of Internet USA, 2.20% with VirtualBank and 2.15% with the National InterBank Banking Center. (See table below for more rates.)

You Can Bank on It
Bank APY Minimum Deposit Other Fees or Requirements
Bank of Internet USA
(877) 541-2634
2.22% $1,500 $10 monthly fee if average balance falls below $1,500; three checks per month.
VirtualBank
(877) 998-2265
2.20% $100 No checks or ATM card.
National InterBank Banking Center
(888) 580-0043
2.15% $1 $4.50 reimbursement per month for use of other banks' ATMs.
Zions First National Bank
(866) 761-8349
2.02% $1000 Six transfers per month (three can be by check); $3 fee for withdrawals at teller window.
Giantbank.com
(877) 446-4200
2.01% $1000 Six transfers per month (three can be by check).
ING Direct
(877) 469-0232
2.00% $1 No checks or ATM card.
NetBank.com
(888) 256-6932
2.00% $100 $75 sign-up bonus.
GMAC Bank
(866) 246-2265
2.00% $500 $5 monthly fee if balance falls below $500; 6 transactions + reimburse four ATM fees per month.
Source: bankrate.com
Note: Those are bankrate.com's top-yielding money market savings accounts that have investment minimums of $1,500 or less and an APY of 2% or more, as of July 03, 2003.

Understandably, online banks can make folks a bit nervous. But don't fret — just check to make sure the bank you're considering is FDIC insured, which requires the federal government to guarantee deposits of up to $100,000. It's easy: Just look for the bank's name (or its parent company's name) in the FDIC directory.

A big red flag: If the bank doesn't have its own Web address, but rather a URL that looks something like members.aol.com/BANKNAME, you should be suspicious, says FDIC spokesman David Barr.

Once you know a bank is legit, talk convenience. Call the banking center and ask if it has minimum deposit requirements and fees, as well as how long it takes for transfers and withdrawals to clear.

Not sold on the Internet bank idea? You can search for rates at local banks by visiting Banx.com and Bankrate.com.