With interest rates at their lowest levels in a generation and effectively yielding nothing on short-term debt instruments, including bank savings accounts, investors face a serious conundrum: just where do you park some of that precious liquidity to boost your effective yield in today’s highly uncertain environment?

Over the last few months I’ve been plugging alternatives for some, not all, of that cash-based portion of the portfolio.

Investors don’t have to stick all of their liquidity into bank savings account in exchange for practically no yield. Combined with depressing headlines about America’s bank insolvency, alternatives have grown scarce amid a severe credit crisis since late 2007.

For a portion of my businesses cash balance I purchased high quality investment grade bonds back in late November, TIPs (Treasury Inflation-Protected Securities) and U.S. government agency mortgage-backed debt. Equally weighted, I’ve raised my dollar-based effective yield from barely 0.50% in November to about 4.2% now.

Excluding investment grade corporate bonds, TIPs and mortgage-backed agency bonds like Fannie Mae and Freddie Mac are government guaranteed so they won’t default. Also, I’m looking to expand this cash cushion by investing in FDIC-backed bank bonds and other agency bonds offering attractive yields and virtually zero credit risk.

I would, however, avoid adding junk bonds or high-yield debt to this mix since the default rate is still climbing. You don’t want to buy junk bonds when defaults are soaring, which is the case right now. If you’re patient, current yields of about 18% for this index will shortly soar to above 25%.

Also, municipal bonds, which will probably come attached with a federal government guarantee shortly, should also be avoided at this stage following a big rally since late December. Many muni bonds will get backstopped by Uncle Sam; still, I’m not buying this segment of the credit market. If you own municipals, make sure to hold only those that come with a government guarantee when that program is announced shortly. Without such a guarantee it’s almost a given that most munis will go bust as the economic recession gathers momentum in 2009.

Don’t dump your T-bills or liquidate all of your bank accounts to boost your yield with the above strategy. Yet, I do think it’s safe to spread some of your yield risk across the highest quality of credits that mostly come backstopped by Uncle Sam. It’s almost free money.