The Money Mustache Community
General Discussion => Welcome and General Discussion => Topic started by: detroital on June 02, 2018, 12:34:53 PM
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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.
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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/
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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.
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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.
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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.
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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.
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But bonds can lose money, CDs cannot.
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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.
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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.
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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" :)
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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?
The strategy of CD laddering is acceptable but non-optimal, since it adds more effort for less reward and less diversification.
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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?
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.
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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.
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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.
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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 (https://en.wikipedia.org/wiki/Federal_Deposit_Insurance_Corporation)
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
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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].
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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.
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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.
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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.
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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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After taxes that 3% on CD is effectively 2.04% for me.
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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.
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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.
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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.
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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
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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.
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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.
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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.
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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.
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A yearly real return of 1.3% would allow a 4% SWR for 30 years.
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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.
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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?
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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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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.
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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.
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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.
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PTF as I am looking into CDs also.
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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?
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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.
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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.
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.
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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
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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.
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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 ...
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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.
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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.
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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.
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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.
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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.
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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.
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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?
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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.
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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?
Show me where it says CDs will give 30 years of living expenses, guaranteed, insured. I think you might get 33, or you might get 22 depending on negative interest rate policy and inflation. Show me where it says I will only last 30 years. Can you show me some reason to think global stocks will return -40% after 30 years? So far the worst case has been a withdrawal rate of more than 3% real, meaning return in isolation was greater than that.
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I am very interested in this topic myself, as I see CDs as good alternative to bonds. Now I wouldn't load up on CDs as a primary investment, as I feel that equities is where you need to be for long term growth, however I also feel that 2 years of living expenses might be reasonable amount to provide an alternate source of income in the event of a down market.
Getting back to the title of this thread, are there any good reasons why I should consider bonds over CDs as a secondary investment to weather a downmarket in equities?
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What if your stash could last you 30 years without investing it at all? Would you still gamble it in stocks and bonds?
Interesting usage of the verb 'gamble' considering 30 years periods of not investing vs. stocks/bonds. Maybe maybe not, depends on one's goals for retirement but that seems like an absurd scenario.
Assuming a 2% inflation rate, you would need ~41x your annual expenses if you never invested any of it (and this is if you live exactly 30 years and would run down to $0 on the day you die). I'd be furious with myself for having worked that hard and far longer than I needed to get to a traditional* SWR that small.
*-without investing, the SWR is still 4% technically but a traditional SWR with more typical investing espoused here would be less than 2.5%. And keep in mind that the non-investing number is going down to zero while the investing number is supposed to stay near the initial level!
As many others have mentioned, it is fine to implement some measures that reduce volatility (especially during those first several years of retirement) but if you take yourself completely out of the stock market for a long period of time, you're only making it harder on yourself.
It just strikes me as a lot more reasonable work a lot less, invest to around 25x spending, keep a solid level of exposure in the stock market while retiring, monitor how things go a bit closely during the first several years of retirement adjusting as needed, and then being able to live for ANY amount of time with a small risk (that you can see coming!) that you'd ever run out of money. Then when you die, have the pile of money (that is likely BIGGER than when you retired) and give it to your family or your favorite charity or scholarships, etc.
However, we're all different. If this is where you find yourself (worked longer than you realized you had to or came into a windfall) or you had a career that you continued after FI simply because you loved it or where you choose to go after not being ignorant of personal finance, that's your choice. In the end, it's all about being happy. Money is just a tool and a rather ineffective one at times at that.
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A bond cannot go down in value if you hold it. A bond can go up in value if interest rates go down and you sell it. A cd will never be worth more than what you start with. As long as you plan on holding the bond I think it would be a better investment. There's always a chance something can happen to cause rates go down from here and you could sell your bond for profit.
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The nominal value of a bond can never go down (as long as the issuer remains solvent and honors it), but the real value certainly can. If you buy a 30 year bond today for at 3.1% interest and inflation goes up to 5% for the next 20 years, then you've lost a lot of money even if you end up cashing it in for the full face value
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The nominal value of a bond can never go down (as long as the issuer remains solvent and honors it), but the real value certainly can. If you buy a 30 year bond today for at 3.1% interest and inflation goes up to 5% for the next 20 years, then you've lost a lot if money even if you end up cashing it in for the full face value
True, but if you could buy a 30 year CD the same would be true. I'm talking about short term us treasuries purchased on the open market, 5 year treasury vs 5 year CD.
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Getting back to the title of this thread, are there any good reasons why I should consider bonds over CDs as a secondary investment to weather a downmarket in equities?
With a bond fund, you could rebalance immediately and without penalty. With a CD, you are locked in for an extended period of time, so you won't be able to rebalance without penalty. Rebalancing helps a portfolio and the SWR success rate.
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Usually, when people are talking about investing in bonds as part of their AA, they are referring to bond funds, not individual bonds.
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The nominal value of a bond can never go down (as long as the issuer remains solvent and honors it), but the real value certainly can. If you buy a 30 year bond today for at 3.1% interest and inflation goes up to 5% for the next 20 years, then you've lost a lot if money even if you end up cashing it in for the full face value
True, but if you could buy a 30 year CD the same would be true. I'm talking about short term us treasuries purchased on the open market, 5 year treasury vs 5 year CD.
In that case, if interest rates rise you can break the 5 yr CD after the first year for a small fee and buy a higher interest one, while the bond must either be sold at a loss or kept the full 5 years at an interest rate below market value.
There's some risk no matter what you do, it's just a matter of taking the right amounts and types of risk for your own situation.
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Probably depends on what the rates are, now maybe not much difference between bond or cd. If rates were at historical levels, 5 to 6 percent and there was a black swan 2008, rates drop to 2 percent your bonds is now worth much more than your cd?
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Imagine if you'd bought 30 year bonds here, best investment in US history?
https://www.nytimes.com/1982/02/05/business/record-set-on-30-year-us-bonds.html
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Probably depends on what the rates are, now maybe not much difference between bond or cd. If rates were at historical levels, 5 to 6 percent and there was a black swan 2008, rates drop to 2 percent your bonds is now worth much more than your cd?
What are you talking about?? The CD is worth the exact same rate as you bought it when it's time to cash it in, except that it generated a nice payout either monthly or semi-annually. It doesn't go down if you let it run it's full term and sends you money, plus it's FDIC insured.
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Imagine if you'd bought 30 year bonds here, best investment in US history?
https://www.nytimes.com/1982/02/05/business/record-set-on-30-year-us-bonds.html
If my aunt had a mustache would she be my uncle?
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Probably depends on what the rates are, now maybe not much difference between bond or cd. If rates were at historical levels, 5 to 6 percent and there was a black swan 2008, rates drop to 2 percent your bonds is now worth much more than your cd?
What are you talking about?? The CD is worth the exact same rate as you bought it when it's time to cash it in, except that it generated a nice payout either monthly or semi-annually. It doesn't go down if you let it run it's full term and sends you money, plus it's FDIC insured.
The CD would have the same value, but the value of the bond would have risen.
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Imagine if you'd bought 30 year bonds here, best investment in US history?
https://www.nytimes.com/1982/02/05/business/record-set-on-30-year-us-bonds.html
If my aunt had a mustache would she be my uncle?
History repeats, look for opportunity
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Getting back to the title of this thread, are there any good reasons why I should consider bonds over CDs as a secondary investment to weather a downmarket in equities?
With a bond fund, you could rebalance immediately and without penalty. With a CD, you are locked in for an extended period of time, so you won't be able to rebalance without penalty. Rebalancing helps a portfolio and the SWR success rate.
I understand that, however, isn't it also possible that cashing out of a bond fund could return you less than your original investment? Sure, a CD cashed out can do that also after penalties, but the penalty at my local credit union is only 90 days worth of interest.
Probably depends on what the rates are, now maybe not much difference between bond or cd. If rates were at historical levels, 5 to 6 percent and there was a black swan 2008, rates drop to 2 percent your bonds is now worth much more than your cd?
What are you talking about?? The CD is worth the exact same rate as you bought it when it's time to cash it in, except that it generated a nice payout either monthly or semi-annually. It doesn't go down if you let it run it's full term and sends you money, plus it's FDIC insured.
The CD would have the same value, but the value of the bond would have risen.
That is not always true, is it?
I am still not clearly seeing how a bond fund could be a better choice than a CD in this rising rate environment. If I invest into a 5 year CD, and after the first year, I want out to secure a higher rate, I simply cash out, minus a 90 day interest penalty (so I still have 3/4ths of the interest), then buy a higher rate CD. Sure, a bond fund could return more, but it could also return less.
Please show me the light if there is any, as I don't see it.
*** Note: This investment is only a small portion of my portfolio, may 10-15%, while the significant portion of my balance remains in equities.
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Put $250K in a 3 percent CD for 3 years that pays monthly and you'll get $625 a month. That's like having rental property income that is guaranteed for 3 years. Why would anyone cash that in early? It's a nice income stream.