It is a simple question, but the answer has rarely been so complicated: Where should you park your cash?  Interest rates are so low these days that the most cautious savers are getting practically nothing in return. Yet the financial crisis showed major risks lurking within supposedly "safe" investments like money-market mutual funds.  Meanwhile, the stock market continues to rally, rewarding risk takers with strong returns—and prompting others to worry that they are keeping too much money in boring old cash.  Joanne Courville is among the investors torn between their fear of risk and their loathing of low yields. Last summer, the 52-year-old director of alumni relations at a university in New Orleans moved about half of her 401(k) balance into a money market fund. "Then I realized I was making 0.03%," Ms. Courville says. She has since moved some money back into annuities and stock funds, but "I'm still scared," she says. "I don't want to lose everything I worked for."  That is a natural impulse, of course. But investors today have to weigh their cash hoard with a cold, calculating eye as well as a careful assessment of their personal risk tolerance.  Some people with very steady income, no fear of losing their job and no dependents may be able to get away with a simple emergency fund holding three months' worth of living expenses.  But most people, including those with high-paying, specialized jobs that could take a long time to replace, high recurring expenses like mortgage and auto payments, or the prospect of big medical or tuition bills, need a more extensive cash plan. These people may want to consider keeping nine months to a year's worth of living expenses spread across a range of cash and near-cash vehicles.  For them, the question of how much money to keep in various types of cash is crucial. Yet, complicating matters, some firms are rolling out new products or updating old ones to boost yield or bolster safety, blurring the lines between traditional cash categories.  So how much cash do you really need, and which types? What follows is a look at the four key cash buckets, from the simplest and safest to the riskiest and most complicated—along with advice on how much to put in each and what risks you should expect.  Everyone should have at least three months' worth of living expenses stowed away in an emergency fund, advisers say. Since you don't know when you might need the money, this cash really should be money in the bank, where it is safe.  With the Federal Deposit Insurance Corp. now covering deposits up to $250,000 per person, per bank—and other conservative investments yielding next to nothing—bank products remain the best bet for emergency funds.  Online savings accounts are offering yields up to just over 1%, according to Bankrate.com. Rewards checking accounts also offer attractive yields, typically on deposits up to about $25,000, says Greg McBride, senior financial analyst at Bankrate. Consumers have to clear some hurdles, like making a certain number of monthly debit-card transactions or using direct deposit, but "if it's a fit for your financial lifestyle, it's a slam dunk," he says.  Despite their current low yields, money-market funds make sense for investors who want a pile of cash that they can move into the stock or bond market at a moment's notice. By contrast, it can take a day or two to pull a big chunk of cash from a savings account and plunk it into a brokerage account.  The price for that flexibility is rock-bottom yields, which "aren't even in the same zip code as the yields on online savings accounts," says Bankrate's Mr. McBride. Taxable money funds yield just 0.03% on average, according to fund tracker iMoneyNet, down from 1.9% in August 2008.  Since there isn't much yield in any corner of the money-fund universe, there isn't any reason to stretch for a few extra hundredths of a percentage point by taking on more risk. Your best bet is to look mainly for safety.  That means eschewing funds that promise above-average returns but hold riskier corporate debt, while focusing instead on products that invest mainly in U.S. Treasurys, such as Fidelity U.S. Treasury Money Market or Schwab U.S. Treasury Money Fund.  People who need to keep as much as a year's worth of cash on hand should put as much as nine months' worth in cash-like investments that carry more risk but offer potentially higher returns, such as short-term bond funds, advisers say.  Typically these funds are fairly stodgy, but the financial crisis showed how risky they can be when markets crack. The ultrashort-term Schwab YieldPlus fund, for example, lost 35% in 2008 because it was too heavily invested in mortgage-backed securities. Today, even funds with high-quality holdings pose the risk of principal losses in a rising-interest-rate environment. (Bond prices fall as interest rates rise.)  The yields, however, are much juicier than those of money-market funds, averaging about 2.4% right now, according to investment research firm Morningstar Inc.  So how to play it? Anyone investing in a short-term bond fund should simply accept the risk of a paper loss over a one-year period, says Miriam Sjoblom, a fund analyst at Morningstar. It only becomes a real loss, after all, if you must sell. Conservative investors also should remember that funds with higher yields than their peers also come with more risk, Ms. Sjoblom says.  Short-term bond funds that get high marks from Morningstar include T. Rowe Price Short-Term Bond and Vanguard Short-Term Bond Index. During its current manager's roughly 16-year tenure, the T. Rowe Price fund's worst 12-month return came in the period ending March 2005, when the Federal Reserve was raising rates and the fund lost about 0.12%, according to Morningstar. The Vanguard fund also saw its worst 12 months during that period, when it lost 0.65%. The fund now yields about 2.2%, while the T. Rowe Price fund yields 2.6%.  Some firms are rolling out new short- and ultrashort-term vehicles aimed at investors who want slightly higher returns than money funds. Be warned: For some investors, the trading costs can eat heavily into returns.  For example, the Pimco Enhanced Short Maturity Strategy exchange-traded fund, launched in late 2009, aims to deliver higher returns than money funds. The actively managed ETF, which already has attracted more than $900 million in assets, gained 1.6% last year, compared with 0.04% for the average taxable money fund tracked by iMoneyNet.  But the fund might not be a great cash vehicle for many smaller investors who deal in more modest investment sums, says Samuel Lee, ETF analyst at Morningstar. In addition to the ETF's annual expenses of 0.35%, investors must consider any commissions paid to buy and sell the fund. An investor who put $1,000 into the fund at the start of each month last year and paid a $7 commission each time would have seen his total commission cost of $84 amount to 1.3% of the average amount he held in the fund during the year—eating up most of the fund's 1.6% return, according to Morningstar.  On the plus side, given the tighter constraints on money-market funds, short-term bond funds' yield advantage over money funds should only grow if interest rates rise, says Jerome Schneider, who manages the ETF.  While investors shouldn't rely on retirement savings for immediate cash needs, they may find that their 401(k) menu includes an option with an attractive yield and a high degree of stability: a "stable value" fund. They can be an attractive cash-like option for savers who are getting close to retirement and want to make sure a big chunk of their holdings are fairly stable.  These funds, available only in tax-deferred savings plans such as 401(k)s, typically consist of a bond portfolio combined with bank or insurance-company "wrap" contracts. These contracts allow investors to trade in and out at a relatively stable value even as the market value of fund holdings fluctuates.  The average stable-value fund now yields around 3%, well above money-fund yields, according to Hueler Cos., which tracks the stable-value industry.  But these funds aren't risk-free. During the market slide, some funds' market value dropped substantially below their book value, and wrap providers became more reluctant to offer these contracts for the funds.  The limited availability of wrap contracts is dragging down returns for stable-value investors. The wrap fees have roughly quadrupled since 2007, to about 0.20% to 0.25%. And wrap providers, having grown more cautious since the financial crisis, are requiring shorter-term and higher-quality investments in the funds.  The wrap providers are asking for "more conservative everything," and have no tolerance for emerging-market debt, high-yield bonds, and other holdings that had previously been allowed in some funds, says Peter Chappelear, an executive director who oversees stable value funds at J.P. Morgan Chase & Co.'s asset-management unit.  FDIC-insured products also are popping up in 401(k) plans—but the benefits are less clear for investors in these plans. BB&T Corp., for example, last summer introduced a FDIC-insured deposit program for 401(k)s, but it currently yields just 0.06%.  Since 401(k)s are for long-term retirement savings, low-yielding FDIC-insured products generally don't make much sense for these plans, 401(k) experts say. And given the inertia of many 401(k) participants, the danger is that "people are going to set it and forget it: move to cash and not get back in the game," says Bankrate's Mr. McBride.  Write to Eleanor Laise at eleanor.laise@wsj.com
With interest rates stuck near zero, investors have little choice but to take on more risk. Here's how to do it smartly.