Author Topic: ***CDs vs Bonds***  (Read 3703 times)

detroital

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***CDs vs Bonds***
« on: June 02, 2018, 12:34:53 PM »
CDs are paying 3% for 3 years now (3.25% for 5 years) and in some cases you can get them to payout monthly.  What do we think about buying CDs instead of bonds for our fixed income needs?  They are FDIC insured while bonds can go up or down in value.
« Last Edit: June 02, 2018, 12:36:46 PM by detroital »

DreamFIRE

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Re: ***CDs vs Bonds***
« Reply #1 on: June 02, 2018, 01:52:35 PM »
I posted this in one of the threads linked to below:

I'll add that just because I have very little in traditional bond funds doesn't mean I'm anywhere near 100% stocks.

Even my mutual funds are diversified including REITs and Metals/Mining and even energy (which hasn't done well in some time.)  And I have a sizeable amount in VG Prime MM and CD's.  And to top it off, my work retirement account has a fixed income 3% guaranteed interest rate with no management fee applicable to that balance which I've been contributing to for a while.

On that topic, see:

https://forum.mrmoneymustache.com/post-fire/what-do-you-invest-in-during-financial-independence/
https://forum.mrmoneymustache.com/investor-alley/is-the-total-bond-market-index-fund-stupid/

Monkey Uncle

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Re: ***CDs vs Bonds***
« Reply #2 on: June 04, 2018, 04:49:50 AM »
I prefer bond mutual funds over individual bonds or CDs.  With an individual security, you have more exposure to interest rate risk and inflation risk.  Yes, you eliminate default risk with the CD, but you're locked in to that 3.25% return for five years, regardless of what happens with interest rates and inflation during that time.  I suppose you could ladder CDs the way people ladder bonds, if you're up for that level of hands-on management.  But still you won't be able to get the same level of diversification and protection against changes in interest rates and inflation that you would get in a bond mutual fund.

VoteCthulu

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Re: ***CDs vs Bonds***
« Reply #3 on: June 04, 2018, 09:41:24 AM »
With an individual security, you have more exposure to interest rate risk and inflation risk.  Yes, you eliminate default risk with the CD, but you're locked in to that 3.25% return for five years, regardless of what happens with interest rates and inflation during that time.
I'm curious in what circumstances a bond fund has less interest rate risk than a CD. If interest rates go up, a bond fund loses principal that can take years to recover, but a CD can only lose whatever amount of interest penalty it has (usually 3-6 months), and then you can buy another CD at the higher interest rate.
« Last Edit: June 04, 2018, 10:02:08 PM by VoteCthulu »

detroital

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Re: ***CDs vs Bonds***
« Reply #4 on: June 04, 2018, 08:14:50 PM »
CDs are FDIC insured and as long as you don't bail on them early, you don't lose anything.  Pretty much a sure thing.

Radagast

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Re: ***CDs vs Bonds***
« Reply #5 on: June 04, 2018, 09:40:49 PM »
6 or half a dozen. Make your bond/CD duration match your need for money, and if that is more than 25 years then no need for bonds. If your need for money is more than 5 years then maybe bond funds are better than CDs.

detroital

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Re: ***CDs vs Bonds***
« Reply #6 on: June 05, 2018, 04:08:05 AM »
But bonds can lose money, CDs cannot. 

Monkey Uncle

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Re: ***CDs vs Bonds***
« Reply #7 on: June 05, 2018, 04:56:02 AM »
With an individual security, you have more exposure to interest rate risk and inflation risk.  Yes, you eliminate default risk with the CD, but you're locked in to that 3.25% return for five years, regardless of what happens with interest rates and inflation during that time.
I'm curious in what circumstances a bond fund has less interest rate risk than a CD. If interest rates go up, a bond fund loses principal that can take years to recover, but a CD can only lose whatever amount of interest penalty it has (usually 3-6 months), and then you can buy another CD at the higher interest rate.

Bond funds are typically diversified across a large number of different issues.  While an individual bond's price may behave as described in the bolded statement, the point of owning a fund is to hedge this risk by holding a large number of bonds with different maturity dates, durations, and coupon rates.

jim555

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Re: ***CDs vs Bonds***
« Reply #8 on: June 05, 2018, 05:58:07 AM »
I would rather hold a CD or a security with a fixed maturity that I hold to the end.  Bond funds generally have no set maturity date and move around a lot due to rate changes.

alanB

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Re: ***CDs vs Bonds***
« Reply #9 on: June 05, 2018, 06:54:38 AM »
CDs are FDIC insured and as long as you don't bail on them early, you don't lose anything.  Pretty much a sure thing.

The strategy of CD laddering is acceptable but non-optimal, since it adds more effort for less reward and less diversification.  A bond fund would also be covered by SIPC which is similar to FDIC.  The inability to bail early subjects you to interest rate risk as well as potential cashflow risk.  Both CDs and bond funds likely suffer from significant opportunity cost, so I would not really agree with "you don't lose anything" :)

Rosy

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Re: ***CDs vs Bonds***
« Reply #10 on: June 05, 2018, 08:09:02 AM »
Since rates are rising, locking in a CD for five years doesn't sound advantageous until rates have stabilized a bit more. I plan to do a bit of CD laddering and I prefer my CD's to be as short-term as possible for now.
In fact, since my current aim is to stay as liquid as possible I like the idea of being able to go to my local CU and cash out the CD on the spot.

@alanB - why do you think that there is less reward in CD laddering? I'm not sure about less diversification either - doesn't it make sense to have access to say one years worth of expenses in a CD to avoid touching the stash/ride out a bad cycle and keeping afloat no matter what?
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The strategy of CD laddering is acceptable but non-optimal, since it adds more effort for less reward and less diversification.

alanB

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Re: ***CDs vs Bonds***
« Reply #11 on: June 05, 2018, 08:38:19 AM »
Since rates are rising, locking in a CD for five years doesn't sound advantageous until rates have stabilized a bit more. I plan to do a bit of CD laddering and I prefer my CD's to be as short-term as possible for now.
In fact, since my current aim is to stay as liquid as possible I like the idea of being able to go to my local CU and cash out the CD on the spot.

@alanB - why do you think that there is less reward in CD laddering? I'm not sure about less diversification either - doesn't it make sense to have access to say one years worth of expenses in a CD to avoid touching the stash/ride out a bad cycle and keeping afloat no matter what?
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The strategy of CD laddering is acceptable but non-optimal, since it adds more effort for less reward and less diversification.

Yes, good point, if you face bad sequence of returns while you are spending down investments you would probably be better off with a CD ladder.  The optimal case is that you have good returns for 10 years after you retire and then you are just always rich forever ;P  If you are spending down a year's worth of investments (presumably 4%?) allocated to CDs vs bonds I don't know if there is a statistically significant difference in potential outcomes.  If you are planning on a 30+ year time scale I would think it would still be better to target the max return vs. risk you are comfortable with and then convert to cash as needed in the most tax-efficient manner available, sequence of returns risk be damned.  So yea, I guess it depends on your risk tolerance.

talltexan

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Re: ***CDs vs Bonds***
« Reply #12 on: June 05, 2018, 08:52:16 AM »
If the bank that issued the CD goes bankrupt, then the FDIC kicks in and makes you whole, right?

If the counterparty of the bond goes bankrupt, then...you may get your money back. But the counterparty of the bond might also be the Federal Government.

VoteCthulu

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Re: ***CDs vs Bonds***
« Reply #13 on: June 05, 2018, 09:09:11 AM »
With an individual security, you have more exposure to interest rate risk and inflation risk.  Yes, you eliminate default risk with the CD, but you're locked in to that 3.25% return for five years, regardless of what happens with interest rates and inflation during that time.
I'm curious in what circumstances a bond fund has less interest rate risk than a CD. If interest rates go up, a bond fund loses principal that can take years to recover, but a CD can only lose whatever amount of interest penalty it has (usually 3-6 months), and then you can buy another CD at the higher interest rate.

Bond funds are typically diversified across a large number of different issues.  While an individual bond's price may behave as described in the bolded statement, the point of owning a fund is to hedge this risk by holding a large number of bonds with different maturity dates, durations, and coupon rates.
Even if the risk is hedged to some extent, it still exists for bonds and doesn't exist for CDs as far as I understand.

I'm not saying that CDs are categorically better than bonds, I just don't understand under what circumstances they have more interest rate risk than bonds.

alanB

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Re: ***CDs vs Bonds***
« Reply #14 on: June 05, 2018, 09:13:33 AM »
If the bank that issued the CD goes bankrupt, then the FDIC kicks in and makes you whole, right?

If the counterparty of the bond goes bankrupt, then...you may get your money back. But the counterparty of the bond might also be the Federal Government.

https://en.wikipedia.org/wiki/Federal_Deposit_Insurance_Corporation
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FDIC deposit insurance is "backed by the full faith and credit of the United States government."
How high do you think you will be on the list of people to pay back when they go bankrupt ;P

Acastus

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Re: ***CDs vs Bonds***
« Reply #15 on: June 05, 2018, 10:54:12 AM »
With an individual security, you have more exposure to interest rate risk and inflation risk.  Yes, you eliminate default risk with the CD, but you're locked in to that 3.25% return for five years, regardless of what happens with interest rates and inflation during that time.
I'm curious in what circumstances a bond fund has less interest rate risk than a CD. If interest rates go up, a bond fund loses principal that can take years to recover, but a CD can only lose whatever amount of interest penalty it has (usually 3-6 months), and then you can buy another CD at the higher interest rate.

Bond funds are typically diversified across a large number of different issues.  While an individual bond's price may behave as described in the bolded statement, the point of owning a fund is to hedge this risk by holding a large number of bonds with different maturity dates, durations, and coupon rates.

Bonds, as a class, lose money when interest rates increase. If a new bond issue pays more interest, all bonds being traded will go down until they match the effective interest of the new one. This happens naturally as people bail out of their old, low paying bond for the shiny new, high paying one.  There will still be a premium for high quality bonds and a discount for junk bonds, but everything will adjust. [technically, the interest adjusts until the net present value of both bonds are equal, but I am simplifying].

jim555

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Re: ***CDs vs Bonds***
« Reply #16 on: June 05, 2018, 11:09:18 AM »
FDIC fears:  US government can just have the Fed open market committee buy bonds or issue a trillion dollar coin, they can never really go bankrupt.

2Birds1Stone

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Re: ***CDs vs Bonds***
« Reply #17 on: June 05, 2018, 11:32:25 AM »
I went through this exercise over the past few days.

Settled on I Bonds, 2.52% APY, they are not taxable by state/local gov, and the fed tax can be deferred till you are FI and in a lower tax bracket. Can purchase up to $10k/yr per SSN.

detroital

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Re: ***CDs vs Bonds***
« Reply #18 on: June 05, 2018, 02:24:20 PM »
I went through this exercise over the past few days.

Settled on I Bonds, 2.52% APY, they are not taxable by state/local gov, and the fed tax can be deferred till you are FI and in a lower tax bracket. Can purchase up to $10k/yr per SSN.

You picked bonds at 2.52% when CDs get you 3% and are FDIC insured?  I don't know what I'm missing, but I don't understand. 

2Birds1Stone

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Re: ***CDs vs Bonds***
« Reply #19 on: June 05, 2018, 02:34:30 PM »
I went through this exercise over the past few days.

Settled on I Bonds, 2.52% APY, they are not taxable by state/local gov, and the fed tax can be deferred till you are FI and in a lower tax bracket. Can purchase up to $10k/yr per SSN.

You picked bonds at 2.52% when CDs get you 3% and are FDIC insured?  I don't know what I'm missing, but I don't understand.
I Bonds don't lock you in to 5 year term. They are more liquid than CD, interest is not taxed. Im,30.6% marginal

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2Birds1Stone

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Re: ***CDs vs Bonds***
« Reply #20 on: June 05, 2018, 02:38:16 PM »
After taxes that 3% on CD is effectively 2.04% for me.

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Monkey Uncle

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Re: ***CDs vs Bonds***
« Reply #21 on: June 05, 2018, 03:30:46 PM »
With an individual security, you have more exposure to interest rate risk and inflation risk.  Yes, you eliminate default risk with the CD, but you're locked in to that 3.25% return for five years, regardless of what happens with interest rates and inflation during that time.
I'm curious in what circumstances a bond fund has less interest rate risk than a CD. If interest rates go up, a bond fund loses principal that can take years to recover, but a CD can only lose whatever amount of interest penalty it has (usually 3-6 months), and then you can buy another CD at the higher interest rate.

Bond funds are typically diversified across a large number of different issues.  While an individual bond's price may behave as described in the bolded statement, the point of owning a fund is to hedge this risk by holding a large number of bonds with different maturity dates, durations, and coupon rates.
Even if the risk is hedged to some extent, it still exists for bonds and doesn't exist for CDs as far as I understand.

I'm not saying that CDs are categorically better than bonds, I just don't understand under what circumstances they have more interest rate risk than bonds.

I wasn't trying to say that individual CDs have more interest rate risk than individual bonds.  What I was trying to say (and should have stated more clearly) is that an individual debt security (whether it be a CD or a bond) doesn't provide any diversification in maturity dates, duration, or coupon rates, whereas a bond mutual fund does.  Instead of being locked in for 5 years as inflation and interest rates rise, some of the fund's holdings will be reaching maturity and can be reinvested at higher rates.

VoteCthulu

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Re: ***CDs vs Bonds***
« Reply #22 on: June 05, 2018, 04:05:12 PM »
But you're not locked in with the vast majority of CDs, you can usually redeem them by giving up some interest.

For example, if Alex bought $10,000 of VBTLX (The total bond market fund) a year ago today for $10.83 per share, he would have gotten about $220 in distributions and it would be worth about $9,612 for a net loss of about $168 (ignoring taxes, ER, etc.)

If Bob bought a 5 year CD for $10,000 from Ally bank a year ago at 1% interest  (I don't know what rates were then, but I doubt they were that low) and sees that the rates are now 2.5%, he can break the CD for a 5 month penalty and has $10,058 to put in the new CD (again ignoring taxes).

This is just one particular case, but if there is some situation where a bond fund has less interest rate risk than a normal CD I'd be interested in hearing about it.
« Last Edit: June 05, 2018, 04:54:12 PM by VoteCthulu »

Frugancial Advisor

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Re: ***CDs vs Bonds***
« Reply #23 on: June 05, 2018, 04:07:31 PM »
With an individual security, you have more exposure to interest rate risk and inflation risk.  Yes, you eliminate default risk with the CD, but you're locked in to that 3.25% return for five years, regardless of what happens with interest rates and inflation during that time.
I'm curious in what circumstances a bond fund has less interest rate risk than a CD. If interest rates go up, a bond fund loses principal that can take years to recover, but a CD can only lose whatever amount of interest penalty it has (usually 3-6 months), and then you can buy another CD at the higher interest rate.

Bond funds are typically diversified across a large number of different issues.  While an individual bond's price may behave as described in the bolded statement, the point of owning a fund is to hedge this risk by holding a large number of bonds with different maturity dates, durations, and coupon rates.
Even if the risk is hedged to some extent, it still exists for bonds and doesn't exist for CDs as far as I understand.

I'm not saying that CDs are categorically better than bonds, I just don't understand under what circumstances they have more interest rate risk than bonds.

I wasn't trying to say that individual CDs have more interest rate risk than individual bonds.  What I was trying to say (and should have stated more clearly) is that an individual debt security (whether it be a CD or a bond) doesn't provide any diversification in maturity dates, duration, or coupon rates, whereas a bond mutual fund does.  Instead of being locked in for 5 years as inflation and interest rates rise, some of the fund's holdings will be reaching maturity and can be reinvested at higher rates.

CDs have zero interest rate risk as defined by a reaction to the increase or decrease of interest rates. The CD will pay the flat rate regardless. Whereas a bond mutual fund carries an expense ratio, and is required to put new money to work. In a rising rate environment, a bond mutual fund is purchasing other bonds at varying durations (depending on the mandate) which are also susceptible to interest rate movements. Personally, I would rather have money laddered in CDs in a rising rate environment than in a bond mutual fund. Liquidity is a secondary issue, and as part of a properly structured portfolio should be a moot point.

DreamFIRE

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Re: ***CDs vs Bonds***
« Reply #24 on: June 05, 2018, 06:55:57 PM »
I'm not going over 2 years on a CD now, so 2.8% before taxes.  My fixed interest fund in my retirement account is 3% ongoing for years now (no expenses, excluded from the plan management fee).  I could rebalance out of that at anytime without penalty within my retirement account.  With rates on the rise, it doesn't look so good as it used to.  The VG Prime MM pays under 2% still but has been on the rise and is liquid in my personal brokerage account.

I plan to purchase an I bond this year, but that's limited to $10K per year for just me, so that is a pretty insignificant portion of my stash.  The inflation adjustment is semi-annual.  You can redeem after one year and prior to 5 years but lose 3 months interest, but penalty free after 5 years.  Compare that to 6 months interest penalty with a CD and and a set maturity date.  No state income tax on the I bond is another advantage for the state I currently live in.

The chart posted here gives you an idea of the lower bond returns in a rising interest rate environment.
https://forum.mrmoneymustache.com/post-fire/what-do-you-invest-in-during-financial-independence/msg1944413/#msg1944413
« Last Edit: June 05, 2018, 07:02:58 PM by DreamFIRE »

detroital

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Re: ***CDs vs Bonds***
« Reply #25 on: June 05, 2018, 08:44:28 PM »
Personally, I doubt that I would ever cash in a CD early.  One attractive thing about them that we haven't discussed is that you can get them that pay monthly, therefore a three year $250K CD @ 3% would pay $625/ month which is a nice steady stream of income for 3 years.  All that and the damn thing is insured!!!  If the market fails, it still pays that steady stream.  I am going to retire at the beginning of next year and I'm thinking that CDs are a safe way to do the 3 percent rule for retirement.  I'm surprised that more aren't onboard.  I'm not crazy about this Las Vegas style stock market.  I've saved for too long to watch it disappear when the market corrects itself.  I don't have time to recover and I sure as hell don't want to go back to work after retiring. 
« Last Edit: June 05, 2018, 08:50:15 PM by detroital »

Radagast

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Re: ***CDs vs Bonds***
« Reply #26 on: June 05, 2018, 08:59:19 PM »
Personally, I doubt that I would ever cash in a CD early.  One attractive thing about them that we haven't discussed is that you can get them that pay monthly, therefore a three year $250K CD @ 3% would pay $625/ month which is a nice steady stream of income for 3 years.  All that and the damn thing is insured!!!  If the market fails, it still pays that steady stream.  I am going to retire at the beginning of next year and I'm thinking that CDs are a safe way to do the 3 percent rule for retirement.  I'm surprised that more aren't onboard.  I'm not crazy about this Las Vegas style stock market.  I've saved for too long to watch it disappear when the market corrects itself.  I don't have time to recover and I sure as hell don't want to go back to work after retiring.
That's not inflation adjusted so it wouldn't work over the long term, but it would still work for 40 years or so if your CD returns stay 1% over inflation.

DreamFIRE

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Re: ***CDs vs Bonds***
« Reply #27 on: June 05, 2018, 09:00:58 PM »
Personally, I doubt that I would ever cash in a CD early.  One attractive thing about them that we haven't discussed is that you can get them that pay monthly, therefore a three year $250K CD @ 3% would pay $625/ month which is a nice steady stream of income for 3 years.  All that and the damn thing is insured!!!  If the market fails, it still pays that steady stream.  I am going to retire at the beginning of next year and I'm thinking that CDs are a safe way to do the 3 percent rule for retirement.  I'm surprised that more aren't onboard.  I'm not crazy about this Las Vegas style stock market.  I've saved for too long to watch it disappear when the market corrects itself.  I don't have time to recover and I sure as hell don't want to go back to work after retiring.

I know what you mean, and I'm trending toward a more conservative AA as I approach FIRE, however, the CD is not a real return of 3%.  Don't forget to factor in inflation.

Radagast

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Re: ***CDs vs Bonds***
« Reply #28 on: June 05, 2018, 09:06:22 PM »
Over the long term, be sure CD's you buy have similar or better yield than high quality bond funds of the same or longer duration, say VBMFX. If you are buying CD's with lower yield than VMBFX then even though there might be less risk in the short term, in the long term there will also be less return, which will eventually become the dominant factor.

DreamFIRE

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Re: ***CDs vs Bonds***
« Reply #29 on: June 05, 2018, 09:09:51 PM »
A yearly real return of 1.3% would allow a 4% SWR for 30 years.

detroital

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Re: ***CDs vs Bonds***
« Reply #30 on: June 05, 2018, 09:12:06 PM »
Do we remember to factor in inflation when we lose our asses in the roulette wheel spin of the stock market???  We don't know what the stock or bond market will do.  The market is over valued now.  It's got to correct itself.  I'd rather be safe.  The Fed will continue to print more money to devalue what we've saved.  Ron Paul calls it the inflation tax. 
« Last Edit: June 05, 2018, 09:13:47 PM by detroital »

Radagast

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Re: ***CDs vs Bonds***
« Reply #31 on: June 05, 2018, 09:39:22 PM »
Do we remember to factor in inflation when we lose our asses in the roulette wheel spin of the stock market???  We don't know what the stock or bond market will do.  The market is over valued now.  It's got to correct itself.  I'd rather be safe.  The Fed will continue to print more money to devalue what we've saved.  Ron Paul calls it the inflation tax.
By the way, if the stock market is a roulette wheel, then investors are the house. They know the odds are stacked in their favor and they'll come out right eventually. Of course we include inflation in down markets, we include it in all our calculations. And inflation is a risk for CD's as much as for anything else, that sounds more like an argument against CDs.

The Fed can't print money. What?
« Last Edit: June 05, 2018, 09:42:19 PM by Radagast »

2Birds1Stone

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Re: ***CDs vs Bonds***
« Reply #32 on: June 06, 2018, 05:11:55 AM »
Do we remember to factor in inflation when we lose our asses in the roulette wheel spin of the stock market???  We don't know what the stock or bond market will do.  The market is over valued now.  It's got to correct itself.  I'd rather be safe.  The Fed will continue to print more money to devalue what we've saved.  Ron Paul calls it the inflation tax.
By the way, if the stock market is a roulette wheel, then investors are the house. They know the odds are stacked in their favor and they'll come out right eventually. Of course we include inflation in down markets, we include it in all our calculations. And inflation is a risk for CD's as much as for anything else, that sounds more like an argument against CDs.

The Fed can't print money. What?
Yup.....the "roulette wheel" is rigged in your favor here....but not for the faint of heart. That's why it's prudent to understand your own risk tolerance and invest accordingly.

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Monkey Uncle

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Re: ***CDs vs Bonds***
« Reply #33 on: June 06, 2018, 05:17:19 AM »
But you're not locked in with the vast majority of CDs, you can usually redeem them by giving up some interest.

For example, if Alex bought $10,000 of VBTLX (The total bond market fund) a year ago today for $10.83 per share, he would have gotten about $220 in distributions and it would be worth about $9,612 for a net loss of about $168 (ignoring taxes, ER, etc.)

If Bob bought a 5 year CD for $10,000 from Ally bank a year ago at 1% interest  (I don't know what rates were then, but I doubt they were that low) and sees that the rates are now 2.5%, he can break the CD for a 5 month penalty and has $10,058 to put in the new CD (again ignoring taxes).

This is just one particular case, but if there is some situation where a bond fund has less interest rate risk than a normal CD I'd be interested in hearing about it.

I should have researched CD penalties instead of assuming an investor would need to stay locked in.  Thanks for providing that info.

Mezzie

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Re: ***CDs vs Bonds***
« Reply #34 on: June 06, 2018, 06:25:04 AM »
I like CDs; that's where I keep my six month emergency fund and where I intend to keep 2-3 years of spending once I retire so I have a little flexibility when it comes to pulling money out of retirement funds.

I have some treasury bonds, but they're mostly intended to be gifts for nieces and nephews as they graduate. I have bond funds as a portion of my retirement accounts.

When returns are almost identical, I think convenience and safety become the deciding factors. CDs win on both.

talltexan

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Re: ***CDs vs Bonds***
« Reply #35 on: June 07, 2018, 06:48:47 AM »
When I was younger, I maintained a "ladder" of CD's as an emergency fund, with $1,700 certificates expiring roughly every month over the next two years. The frequent expirations meant that I was fairly liquid, but it took some effort to establish those over a couple of years. Having them with the same bank as my primary checking account made it easy to move them back and forth.

katsiki

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Re: ***CDs vs Bonds***
« Reply #36 on: June 07, 2018, 07:57:05 AM »
PTF as I am looking into CDs also.

Rosy

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Re: ***CDs vs Bonds***
« Reply #37 on: June 07, 2018, 05:32:46 PM »
Personally, I doubt that I would ever cash in a CD early.  One attractive thing about them that we haven't discussed is that you can get them that pay monthly, therefore a three year $250K CD @ 3% would pay $625/ month which is a nice steady stream of income for 3 years.  All that and the damn thing is insured!!!  If the market fails, it still pays that steady stream.  I am going to retire at the beginning of next year and I'm thinking that CDs are a safe way to do the 3 percent rule for retirement.  I'm surprised that more aren't onboard.  I'm not crazy about this Las Vegas style stock market.  I've saved for too long to watch it disappear when the market corrects itself.  I don't have time to recover and I sure as hell don't want to go back to work after retiring.
That's not inflation adjusted so it wouldn't work over the long term, but it would still work for 40 years or so if your CD returns stay 1% over inflation.
@Radagast
Now that's an interesting plan - I have less than 40 years to live, but of course, there is no guarantee that the CD returns stay 1% over inflation. Damn, there's always a fly in the ointment.
What would it do if I don't spend that $625 mo and plow it back in? or would it be better to put that $625 in the stock market/index funds - say for 25-30 years?

Rosy

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Re: ***CDs vs Bonds***
« Reply #38 on: June 07, 2018, 05:39:33 PM »
After taxes that 3% on CD is effectively 2.04% for me.

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Interesting point - I hadn't considered tax situations, because I don't even think of CD's as an investment, more like a fancy savings account. In my case, it remains 3% for me.
...FWIW there are CD's that have no early WD penalties, I believe Ally offered one not too long ago.

DreamFIRE

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Re: ***CDs vs Bonds***
« Reply #39 on: June 07, 2018, 07:11:16 PM »
After taxes that 3% on CD is effectively 2.04% for me.

Sent from my SAMSUNG-SM-G930A using Tapatalk

Interesting point - I hadn't considered tax situations, because I don't even think of CD's as an investment, more like a fancy savings account. In my case, it remains 3% for me.
...FWIW there are CD's that have no early WD penalties, I believe Ally offered one not too long ago.

The no penalty CD has only 1.5% APY.  I get more than that from my VG Prime MM, double that in my retirement account fixed income fund, and you can get double that in a 3 year CD.  I would settle for 2.8% in a 2 year CD.

In addition to any income tax someone have due on interest, there's also the inflation factor.

Radagast

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Re: ***CDs vs Bonds***
« Reply #40 on: June 07, 2018, 07:47:01 PM »
Personally, I doubt that I would ever cash in a CD early.  One attractive thing about them that we haven't discussed is that you can get them that pay monthly, therefore a three year $250K CD @ 3% would pay $625/ month which is a nice steady stream of income for 3 years.  All that and the damn thing is insured!!!  If the market fails, it still pays that steady stream.  I am going to retire at the beginning of next year and I'm thinking that CDs are a safe way to do the 3 percent rule for retirement.  I'm surprised that more aren't onboard.  I'm not crazy about this Las Vegas style stock market.  I've saved for too long to watch it disappear when the market corrects itself.  I don't have time to recover and I sure as hell don't want to go back to work after retiring.
That's not inflation adjusted so it wouldn't work over the long term, but it would still work for 40 years or so if your CD returns stay 1% over inflation.
@Radagast
Now that's an interesting plan - I have less than 40 years to live, but of course, there is no guarantee that the CD returns stay 1% over inflation. Damn, there's always a fly in the ointment.
What would it do if I don't spend that $625 mo and plow it back in? or would it be better to put that $625 in the stock market/index funds - say for 25-30 years?
There are 30-years Treasury Inflation Protected Securities (TIPS bonds) at around 1% though ;). Unfortunately only out to 30 years, and not maturing in every year between now and then. There is a method called "liability matching" where you would use these and Social Security / pensions to account for 100% of your bare minimum costs out to 30 years, and extravagant costs and costs beyond 30 years would be in stocks. I personally would be scared to use only TIPS, and would want 50/50 with stocks at least. https://www.bogleheads.org/forum/viewtopic.php?t=226541

intellectsucks

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Re: ***CDs vs Bonds***
« Reply #41 on: June 08, 2018, 12:02:15 PM »
When the economy tanks, stocks and bonds will see a couple of years of losses/low returns. CDs could see multiple years of near zero returns. If you look at CD returns from 2008 through now, you see almost a DECADE of returns paying around 1% or less. Your $625 in monthly income on a $250k CD would be $156.25 at 0.75% yield. Sometime in the next 20 years, the economy will crash again and interest rates will likely be pushed to near zero again. Will your stache be able to handle a decade of sub 1% returns? If not are you likely to be more risk tolerant in the future and more likely to move assets into stocks and bonds?
Additionally, CDs have always paid rates below inflation in my experience.
This isn't to say that CDs are always a bad call, or can't be a good addition to your stache, they're just very unlikely to pay the long term yields most people need.

Rosy

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Re: ***CDs vs Bonds***
« Reply #42 on: June 08, 2018, 12:43:00 PM »
When the economy tanks, stocks and bonds will see a couple of years of losses/low returns. CDs could see multiple years of near zero returns. If you look at CD returns from 2008 through now, you see almost a DECADE of returns paying around 1% or less. Your $625 in monthly income on a $250k CD would be $156.25 at 0.75% yield. Sometime in the next 20 years, the economy will crash again and interest rates will likely be pushed to near zero again. Will your stache be able to handle a decade of sub 1% returns? If not are you likely to be more risk tolerant in the future and more likely to move assets into stocks and bonds?
Additionally, CDs have always paid rates below inflation in my experience.
This isn't to say that CDs are always a bad call, or can't be a good addition to your stache, they're just very unlikely to pay the long term yields most people need.

Yes, that's what I thought. I'll stick to my original plan of a year or two of income in CD/cash using a CD ladder approach. That would only be $100K. We also have an annuity that we can draw from any time which should get us through tough times.

It is scary though to expose the real stash to the stock market when it is only $500K. If the market crashed 50% tomorrow and we need that money in 6-10 years is there even a chance we'd still have $500K?

I think the OPs point was that he doesn't want to lose any of his stash - so he is willing to accept the possibility of sub 1% returns in exchange for holding onto his principle amount. He would be OK forgoing a possible 7% or 8% return in the stock market now for receiving 3% in interest in a CD - without having to worry about losing 50% in a sudden drop.

But then there is always inflation and taxes to consider ...

 

Rosy

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Re: ***CDs vs Bonds***
« Reply #43 on: June 08, 2018, 12:48:36 PM »
Personally, I doubt that I would ever cash in a CD early.  One attractive thing about them that we haven't discussed is that you can get them that pay monthly, therefore a three year $250K CD @ 3% would pay $625/ month which is a nice steady stream of income for 3 years.  All that and the damn thing is insured!!!  If the market fails, it still pays that steady stream.  I am going to retire at the beginning of next year and I'm thinking that CDs are a safe way to do the 3 percent rule for retirement.  I'm surprised that more aren't onboard.  I'm not crazy about this Las Vegas style stock market.  I've saved for too long to watch it disappear when the market corrects itself.  I don't have time to recover and I sure as hell don't want to go back to work after retiring.
That's not inflation adjusted so it wouldn't work over the long term, but it would still work for 40 years or so if your CD returns stay 1% over inflation.
@Radagast
Now that's an interesting plan - I have less than 40 years to live, but of course, there is no guarantee that the CD returns stay 1% over inflation. Damn, there's always a fly in the ointment.
What would it do if I don't spend that $625 mo and plow it back in? or would it be better to put that $625 in the stock market/index funds - say for 25-30 years?
There are 30-years Treasury Inflation Protected Securities (TIPS bonds) at around 1% though ;). Unfortunately only out to 30 years, and not maturing in every year between now and then. There is a method called "liability matching" where you would use these and Social Security / pensions to account for 100% of your bare minimum costs out to 30 years, and extravagant costs and costs beyond 30 years would be in stocks. I personally would be scared to use only TIPS, and would want 50/50 with stocks at least. https://www.bogleheads.org/forum/viewtopic.php?t=226541

I looked, thanks Radagast - I think that is way too tricky for us to contemplate.

intellectsucks

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Re: ***CDs vs Bonds***
« Reply #44 on: June 08, 2018, 01:47:42 PM »
Rosy- the comparison isn't between extremely volatile assets and extremely safe assets. The comparison is between extremely safe assets and slightly more stable assets. Over the last ten years a total bond fund averaged 3.54%, while CDs paid less than 1%. During that time the total bond fund had only one down year of 2.15%.  this yield difference is the norm, not the exception.
To me the tiny reduction in volatility is not worth the much lower returns.

Radagast

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Re: ***CDs vs Bonds***
« Reply #45 on: June 08, 2018, 03:14:16 PM »
Rosy- the comparison isn't between extremely volatile assets and extremely safe assets. The comparison is between extremely safe assets and slightly more stable assets. Over the last ten years a total bond fund averaged 3.54%, while CDs paid less than 1%. During that time the total bond fund had only one down year of 2.15%.  this yield difference is the norm, not the exception.
To me the tiny reduction in volatility is not worth the much lower returns.
Where are you getting your CD rates, from big box banks and local lenders? Online CDs have been competitive with total bond's SEC yield, with the bond fund generally receiving an additional boost from the yield curve and declining rates. CDs are not a miracle and will probably not boost your SWR by more than 0.1% compared using total bond in your allocation, but the competitive FDIC internet ones do give good return relative to their small risk.

detroital

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Re: ***CDs vs Bonds***
« Reply #46 on: June 08, 2018, 05:19:44 PM »
Go to Fidelity and see 3 yr CDs for 3% and 5 yr for 3.25.  With everyone shooting for 3 or 4 percent withdrawal for retirement, how is 3 percent on a very low risk investment a bad thing?  You can stream in income monthly with CDs.  Stocks and bonds are a big risk, especially now that the market is sky high.  I don't see the downside.  I'm getting ready to retire soon and don't feel like gambling my life savings to any great extent. 
« Last Edit: June 08, 2018, 05:24:54 PM by detroital »

Radagast

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Re: ***CDs vs Bonds***
« Reply #47 on: June 08, 2018, 06:27:38 PM »
Go to Fidelity and see 3 yr CDs for 3% and 5 yr for 3.25.  With everyone shooting for 3 or 4 percent withdrawal for retirement, how is 3 percent on a very low risk investment a bad thing?  You can stream in income monthly with CDs.  Stocks and bonds are a big risk, especially now that the market is sky high.  I don't see the downside.  I'm getting ready to retire soon and don't feel like gambling my life savings to any great extent.
Choosing 1% real returns over 4% real returns. Now *there's* a temporary solution. I might understand a 5-year rolling CD ladder as 20% of your investments, but beyond that you are probably working against yourself.

detroital

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Re: ***CDs vs Bonds***
« Reply #48 on: June 10, 2018, 07:23:12 PM »
Choosing 1% real returns over 4% real returns. Now *there's* a temporary solution. I might understand a 5-year rolling CD ladder as 20% of your investments, but beyond that you are probably working against yourself.
[/quote]


Show me where I can get 4 percent real returns, guaranteed and insured.  I don't believe it.  I think you may get 4 percent or lose 40 percent. 

BTW, I have 9 percent of my nest egg in CDs currently.  I'll probably ramp it up quite a bit. 

What if your stash could last you 30 years without investing it at all?  Would you still gamble it in stocks and bonds?
« Last Edit: June 10, 2018, 07:43:38 PM by detroital »

One

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Re: ***CDs vs Bonds***
« Reply #49 on: June 10, 2018, 07:59:28 PM »
I don't think treasury bonds are taxed at the state or local level so jf you live in a state like Oregon you'd save 9 percent of income vs cd? I think a short term bond would be better in a state with high taxes.