Why do Callable CDs get such a bad rap?

[Unionville]

I've read pros and cons of callable CDs, but the arguments against them are flawed and make assumptions about how I will spend the money returned to me.  I feel like it's better to buy callable CDs at a high rates, and if they are returned to me early - so what?  I still got a high rate for the time I owned them. 

I can take the early returned money and buy stocks or live off of it.  I'm not forced to buy more CD's at a lower rate (which is the main argument against them)

You get the high rate for the length the CD is held. If other CD rates in the market go up and down - that is irrelevant to me since I'm only interested in 6%.  I might not have any interest in buying more CDs.

For example, If I buy a 5 year callable CD for 6% and they pay it back in one year (early)  - it's still a better deal than buying a 1 year non-callable CD for 5%. It seems logical to me to just buy all callable CD's at a higher return rate.

Your thoughts?

[blue_green_sparks]

To me the whole point of a CD is to lock in a certain rate for a specific time, but sure, playing it as you suggest is certainly an option. I recall years ago, every time rates went down by 0.25% or more, I have had my brokered CDs called-in and I believe it took a few days for the cash to end up in my core position, so that's a bit of lost interest. Generally, I just avoid callable anything these days, but I did notice the MYGAs (AKA CD annuities) often have higher rates than CDs and usually can't be called. I recently let a Gainbridge, 3 year, (online contract) annuity roll-over at 5.5%. Tax deferred and counts as income the year you cash out.

[nouseforausername]

The call premium feels like a teaser rate / the issuer's hedging against a rate drop.

You cant withdrawal at any time penalty free(?)), but the issuer can? And unlike callable preferred stock and other instruments, the poster above's anecdote makes it seem like it's more common for that to happen.

[ChpBstrd]

It's kind of a heads they win, tails you lose situation:

• If rates rise, you lose because you locked in your money at a lower interest rate than you could have received in variable instruments or by waiting.
• If rates fall, you lose because your alternatives to reinvest the money yield less. As a retiree, this means your income went down, even though that was exactly the outcome you were trying to avoid by investing in a risk-free asset!

Rates are typically cut just prior to or during a recession, which means just prior to a recession is the most likely time you'll find your CDs called. Thus to maintain the same income, you'll be shifting into riskier assets right before risky assets lose value. A person who bought a treasury instead of a CD right before a couple hundred basis points of rate cuts would be able to ride out the recession without losing any of their income or taking on additional risk. PLUS, if the treasury had a few years of duration, it would appreciate as rates were cut, giving the investor an opportunity to sell bonds when they're up to buy stocks when they're down.

With a callable CD, in contrast, you're along for the ride in a semi-illiquid state until the bank finds a better deal.

I have a lot invested in callable CDs right now, but they all mature well before I think we're going to see any significant rate cuts. I can't bring myself to go out more than a year on these instruments.

[Unionville]

It's kind of a heads they win, tails you lose situation:

• If rates rise, you lose because you locked in your money at a lower interest rate than you could have received in variable instruments or by waiting.
• If rates fall, you lose because your alternatives to reinvest the money yield less. As a retiree, this means your income went down, even though that was exactly the outcome you were trying to avoid by investing in a risk-free asset!

For sake of argument:
Regarding 1. What if I don't care about what other rates are or if they are rising (or lowering) -If I'm happy with 6%? Otherwise, it's like falling into the trap of "fear of missing out" or buying a pair of shoes you want, but can't stop worrying about what price they might be in the future. If I can get 6%, why wait around for a "might get" price?  A lot of bond funds didn't even come near 6% in the last 10 years.

Regarding 2. My alternatives could be buying stocks or living off the income.  No one is forcing me to rebuy the CDs. That also seems like a win too.

[ChpBstrd]

It's kind of a heads they win, tails you lose situation:

• If rates rise, you lose because you locked in your money at a lower interest rate than you could have received in variable instruments or by waiting.
• If rates fall, you lose because your alternatives to reinvest the money yield less. As a retiree, this means your income went down, even though that was exactly the outcome you were trying to avoid by investing in a risk-free asset!

For sake of argument:
Regarding 1. What if I don't care about what other rates are or if they are rising (or lowering) -If I'm happy with 6%? Otherwise, it's like falling into the trap of "fear of missing out" or buying a pair of shoes you want, but can't stop worrying about what price they might be in the future. If I can get 6%, why wait around for a "might get" price?  A lot of bond funds didn't even come near 6% in the last 10 years.

Suppose we have a 1970's scenario ahead of us. Inflation will bounce back up to 10% and the federal funds rate will go up to 12%. Your 6% CD will be locked into losing 4% real for its remaining duration. I'm not saying this is likely, but saying that if rates/inflation rise you'll be living with some regret and you'll be enduring negative real returns.

Regarding 2. My alternatives could be buying stocks or living off the income.  No one is forcing me to rebuy the CDs. That also seems like a win too.

If you go from a risk-free asset to buying a risky asset, you have changed your asset allocation. To keep the same AA, you'd have to refill the risk-free portion by buying treasuries, agencies, or more CDs. This is kind of like saying if plan A doesn't work out I'll just buy Apple stock and win that way.

Not sure what is meant by living off the income. When the CD is called away, you lose access to a source of income. If, for example, you reinvest those funds at 3% after your 6% CD is called away, your income has taken a cut. If you pivot into stocks with a 1.5% yield, you're income has taken a cut.

[Unionville]

Not sure what is meant by living off the income. When the CD is called away, you lose access to a source of income. If, for example, you reinvest those funds at 3% after your 6% CD is called away, your income has taken a cut. If you pivot into stocks with a 1.5% yield, you're income has taken a cut.

What I mean by "living off the income" is literal (vs cashing out a mutual fund). In other words, when the CD term ends, and the money is deposited back into my money market - I will just use that account for expenses.

Perhaps one thing I neglected to say in all this - is I am only buying 1-3 year CD's, so I would not end up in a really long holding period.  Therefore less risk.  It just made sense to me to buy a 2 year callable for 6% for a higher rate, than a 1 year non callable for 5%.  If the callable gets called, I've still gotten 6% for that one year (rather than the 5%). Does this makes sense?

[ChpBstrd]

Not sure what is meant by living off the income. When the CD is called away, you lose access to a source of income. If, for example, you reinvest those funds at 3% after your 6% CD is called away, your income has taken a cut. If you pivot into stocks with a 1.5% yield, you're income has taken a cut.

What I mean by "living off the income" is literal (vs cashing out a mutual fund). In other words, when the CD term ends, and the money is deposited back into my money market - I will just use that account for expenses.

Perhaps one thing I neglected to say in all this - is I am only buying 1-3 year CD's, so I would not end up in a really long holding period.  Therefore less risk.  It just made sense to me to buy a 2 year callable for 6% for a higher rate, than a 1 year non callable for 5%.  If the callable gets called, I've still gotten 6% for that one year (rather than the 5%). Does this makes sense?

OK, so you're only allocating money to CDs in a way where the likely call dates align with your spending, and basically withdrawing planned spending from the CDs as they mature or are called. There's no issue with doing that, but what happens after high CD yields go away? Do you keep a couple years' worth of spending in a MM account earning next to nothing? Or do you adjust your AA to keep less money in cash and more in riskier investments? I guess what I'm suggesting is that this plan which looks good today won't look as good in a year or two if CDs are back to yielding less than inflation by that time.