When is a bank CD safer than a bond fund?

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When is a bank CD safer than a bond fund?

Postby Swampy » Thu Jan 31, 2013 7:22 am

As part of the 50-50 stock/bond mix, I'm reassessing whether there is more risk in bonds now than it's worth.

I can get 1% in a bank savings account and up to 1.7% for a 2-3 year FDIC insured CD. I don't believe that short term bonds offer that currently without the associated risks. Certainly high yield, intermediate and long term bonds do not.

Given the current low interest rates, I'm actually thinking of just utilizing CD's for the 50% I had planned on investing in bonds until such time as bonds, once again, offer competitive returns.

The other 50%, I will dollar cost average in equity index funds with a slight overweight toward international versus US holdings.

What do you say?
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Re: When is a bank CD safer than a bond fund?

Postby z3r0c00l » Thu Jan 31, 2013 7:58 am

CDs are certainly safer than any bond fund I can think of, though not much safer than short term which is also quite safe. 1.7% is pretty good for any CD right now, but you will be somewhat locked in to that rate for a while, during which time rates may go up. I would consider CDs part of an emergency fund, unless you are retired, and bonds part of your investment funds proper. Consider a CD ladder.

As for dollar cost average, I would suggest you pick a plan and buy all right away. 2/3rds of the time, DCA is worse than lump sum.
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Re: When is a bank CD safer than a bond fund?

Postby Call_Me_Op » Thu Jan 31, 2013 8:01 am

No question that a 2-3 year CD earning 1.7% is a far better deal than any bond fund.
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Re: When is a bank CD safer than a bond fund?

Postby Leesbro63 » Thu Jan 31, 2013 8:07 am

CDs also offer a "put" option in the form of the ability to redeem early at a small cost.if rates rise significantly, this could be very valuable.
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Re: When is a bank CD safer than a bond fund?

Postby Call_Me_Op » Thu Jan 31, 2013 9:35 am

Leesbro63 wrote:CDs also offer a "put" option in the form of the ability to redeem early at a small cost.if rates rise significantly, this could be very valuable.


Maybe. Be sure to read the fine print. Some banks retain the right to change the early redemption terms.
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Re: When is a bank CD safer than a bond fund?

Postby Valuethinker » Thu Jan 31, 2013 9:36 am

Swampy wrote:As part of the 50-50 stock/bond mix, I'm reassessing whether there is more risk in bonds now than it's worth.

I can get 1% in a bank savings account and up to 1.7% for a 2-3 year FDIC insured CD. I don't believe that short term bonds offer that currently without the associated risks. Certainly high yield, intermediate and long term bonds do not.

Given the current low interest rates, I'm actually thinking of just utilizing CD's for the 50% I had planned on investing in bonds until such time as bonds, once again, offer competitive returns.

The other 50%, I will dollar cost average in equity index funds with a slight overweight toward international versus US holdings.

What do you say?


You lose some liquidity, but it's one of the few cases in capitla markets where the small saver, via FDIC insured CDs, can get a better rate than the big players.
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Re: When is a bank CD safer than a bond fund?

Postby papito23 » Thu Jan 31, 2013 9:50 am

Since someone inevitably mentions them but hasn't yet, I will: iBonds can do the job too, but only $10K/SSN/yr. Current yield is 1.76%. May go up or down, but you won't be hit by unexpected inflation.
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Re: When is a bank CD safer than a bond fund?

Postby john94549 » Thu Jan 31, 2013 9:52 am

I am a fan of CD ladders, with one major caveat. Always keep enough in bond funds to re-balance, if necessary. Attempting to re-balance with a CD ladder can be cumbersome. For the OP, this might be 10% of the portfolio (in bond funds).

In addition, while that 3-year CD might sound good today, who knows what it might be in a year or so. I have noted in other threads alternatives for constructing a CD ladder from existing bond funds. A certain amount of patience might be prudent.
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Re: When is a bank CD safer than a bond fund?

Postby rkhusky » Thu Jan 31, 2013 10:48 am

I am now seeing CD's with flat early withdrawal penalties of 1%-3%, rather than 3-12 months of interest. Might want to keep an eye out for that too (along with language indicating that the bank reserves the right to not let you withdraw early). At least if they change terms midway through the term, you can always withdraw your principal/interest without penalty.
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Re: When is a bank CD safer than a bond fund?

Postby dm200 » Thu Jan 31, 2013 11:30 am

rkhusky wrote:I am now seeing CD's with flat early withdrawal penalties of 1%-3%, rather than 3-12 months of interest. Might want to keep an eye out for that too (along with language indicating that the bank reserves the right to not let you withdraw early). At least if they change terms midway through the term, you can always withdraw your principal/interest without penalty.


Yes, many banks and credit unions have increased the penalties. The reason is that, if/when interest rates rise significantly, many holders of CDs may pull out the funds, pay a small penalty and get the new, higher rates. it is financially prudent for them to have higher penalties.
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Re: When is a bank CD safer than a bond fund?

Postby Grandpaboys » Thu Jan 31, 2013 7:13 pm

Local Credit Union now offering 30 months CD with yield of 2.5%. Will buy one tomorrow.
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Re: When is a bank CD safer than a bond fund?

Postby nisiprius » Thu Jan 31, 2013 7:20 pm

In my opinion, FDIC-insured bank CDs, owned directly by the investor (i.e. not brokered CDs) are always safer than a bond fund. What's interesting is that for the first time, they might be comparable or better in return than a bond fund. Certainly they are better than money market mutual funds--and that in itself is a new thing.
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Re: When is a bank CD safer than a bond fund?

Postby dm200 » Thu Jan 31, 2013 7:39 pm

nisiprius wrote:In my opinion, FDIC-insured bank CDs, owned directly by the investor (i.e. not brokered CDs) are always safer than a bond fund. What's interesting is that for the first time, they might be comparable or better in return than a bond fund. Certainly they are better than money market mutual funds--and that in itself is a new thing.


FDIC insured, brokered CDs are, I believe, just as "safe" as those issued directly to purchasers from FDIC insured banks/thrifts or NCUA insured credit unions. You will get your principal and accrued interest, as long as you are under the $250,000 maximum per institution.If you need/want the money before maturity, you may get less on the secondary market than taking a penalty, but you might get more. There is a small degree of "call risk" if the bank goes belly up and the CD is redeemed early, but you get 100% of the principal and interest to the redemption.
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Re: When is a bank CD safer than a bond fund?

Postby BrandonBogle » Thu Jan 31, 2013 8:49 pm

I've thought about this too in helping a family member in starting their retirement investment. We can get a 3 year or 4 year CD at 1.85% with a 6-month early withdrawal penalty (and guarantee NOT to remove more than earned interest should you need the funds next week). We are considering put her allotment of "short term bonds" into this CD instead. The thought would be to still invest in a intermediate term bond fund. What is the consensus? Sound good for someone already in retirement?
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Re: When is a bank CD safer than a bond fund?

Postby tfb » Thu Jan 31, 2013 9:00 pm

nisiprius wrote:What's interesting is that for the first time, they might be comparable or better in return than a bond fund. Certainly they are better than money market mutual funds--and that in itself is a new thing.

Are we sure about this? Maybe people just haven't paid enough attention? Could it be that CDs have always had comparable or better in return than a bond fund if you find the right places?
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Re: When is a bank CD safer than a bond fund?

Postby nydad » Thu Jan 31, 2013 11:13 pm

Isn't it the case that CDs are always safer than bond
Funds? CDs have no risk of principal loss.

However in spite of interest rate that
Many pundits have said can go no lower, vfitx has returned
Around 6% over the last 3 years - and that's a
Pretty safe fund (100% treasuries) esp if u hold it through the
5 year average duration. So you will be
Safer in CDs but you aren't guaranteed to
Make more money...
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Re: When is a bank CD safer than a bond fund?

Postby BrandonBogle » Thu Jan 31, 2013 11:36 pm

For my mom's portfolio that I'm helping her with, I'm planning to use a 1.85% 4-year for her "short-term" bond holdings. I'm still planning to give her TBM for the rest of her bond position. The cd only has a 6-month penalty and we have other CDs maturing in intervening years.
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Re: When is a bank CD safer than a bond fund?

Postby FinancialDave » Fri Feb 01, 2013 12:20 am

BrandonBogle wrote:I've thought about this too in helping a family member in starting their retirement investment. We can get a 3 year or 4 year CD at 1.85% with a 6-month early withdrawal penalty (and guarantee NOT to remove more than earned interest should you need the funds next week). We are considering put her allotment of "short term bonds" into this CD instead. The thought would be to still invest in a intermediate term bond fund. What is the consensus? Sound good for someone already in retirement?


This thread seems to be much confused between the concept of "safeness" or risk and the concept of return (or risk adjusted return if you like). I am not particularly picking on this post, only using it to point out some possible problems.

Certainly CD's in most cases are FDIC insured and principal protected -- truly about the same risk as an I-bond (IMO). NO bond funds at all fall into this category.

As far as the return side of the equation, this can NOT be predicted entirely by the bond duration or anything else for that reason -- there just is no model that covers all scenarios. Holding a bond fund past it's duration is also no guarantee that you will end up with a positive return. It is not uncommon for a bond fund of 10 years duration to hold bonds in it of 25 or 30 years, that when forced to be sold could be sold at a substantial loss. You are at the mercy of interest rates, redemptions of bond holders, and the good fortune (or skill as the case may be) of the bond fund manager and the combination of the three - not an easy task to juggle or predict.

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Re: When is a bank CD safer than a bond fund?

Postby BrandonBogle » Fri Feb 01, 2013 12:42 am

FinancialDave wrote:
BrandonBogle wrote:I've thought about this too in helping a family member in starting their retirement investment. We can get a 3 year or 4 year CD at 1.85% with a 6-month early withdrawal penalty (and guarantee NOT to remove more than earned interest should you need the funds next week). We are considering put her allotment of "short term bonds" into this CD instead. The thought would be to still invest in a intermediate term bond fund. What is the consensus? Sound good for someone already in retirement?


This thread seems to be much confused between the concept of "safeness" or risk and the concept of return (or risk adjusted return if you like). I am not particularly picking on this post, only using it to point out some possible problems.

Certainly CD's in most cases are FDIC insured and principal protected -- truly about the same risk as an I-bond (IMO). NO bond funds at all fall into this category.

As far as the return side of the equation, this can NOT be predicted entirely by the bond duration or anything else for that reason -- there just is no model that covers all scenarios. Holding a bond fund past it's duration is also no guarantee that you will end up with a positive return. It is not uncommon for a bond fund of 10 years duration to hold bonds in it of 25 or 30 years, that when forced to be sold could be sold at a substantial loss. You are at the mercy of interest rates, redemptions of bond holders, and the good fortune (or skill as the case may be) of the bond fund manager and the combination of the three - not an easy task to juggle or predict.

fd


Sorry, I'm new to BogleHeads, so I could pick up on whether you were say for or against in my post while clearing the confusion of the thread. I agree that this shouldn't be used to protect against inflation. For her holdings, I'm still recommending she gets bonds. This would substitute the short term bond fund thought that she would be looking to tap into in the next two or so years. With such a short timeframe, stability is worth much to her. More info here (http://www.bogleheads.org/forum/viewtopic.php?f=1&t=109885). This would basically be 15% - 27% of her total holdings. Just got to see how TIPS compare to see if this would replace TIPS as well or coexist with them
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Re: When is a bank CD safer than a bond fund?

Postby FinancialDave » Fri Feb 01, 2013 2:16 am

BrandonBogle wrote:
Sorry, I'm new to BogleHeads, so I could pick up on whether you were say for or against in my post while clearing the confusion of the thread. I agree that this shouldn't be used to protect against inflation. For her holdings, I'm still recommending she gets bonds. This would substitute the short term bond fund thought that she would be looking to tap into in the next two or so years. With such a short timeframe, stability is worth much to her. More info here (http://www.bogleheads.org/forum/viewtopic.php?f=1&t=109885). This would basically be 15% - 27% of her total holdings. Just got to see how TIPS compare to see if this would replace TIPS as well or coexist with them


Brandon,
I am just one of those a little concerned with the intermediate bond universe right now. I was just downloading a bunch of my portfolios from M* and notice most Intermediate bond funds are already down almost 1% just in Jan. Most people invest in these funds not knowing they can drop 10-20% pretty easily under the right conditions. It does look like you have a fairly conservative approach, but you do need to be in a position where you don't have to draw from the intermediate bond funds for up to at least 5 years, if you want to try and maintain the principal, so if you could get $60k-$70k in CD's or I-Bonds or a combination of the two she should be ok.

I would suggest to definitely pay off the car loan with some of the current Intermediate bond fund money -- this is a guaranteed 1.5% payback, which I doubt you will get from these, and even if you do it certainly is not guaranteed. Paying down debt is always a good guarantee. Then you may consider how much income would be freed up by paying off the mortgage. This is a little tougher decision, but here it looks like the guarantee is 2.75% -- it's not likely you will get this out of any of the bond funds in the next 3-5 years (pure guess on my part.) Once again its a guaranteed return.

That's about all I can comment on with the brief look I took.

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Re: When is a bank CD safer than a bond fund?

Postby letsgobobby » Fri Feb 01, 2013 2:26 am

I happily accept the 1% loss in my bond funds this month, since my stock funds were up, what, 6% in 31 days?
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Re: When is a bank CD safer than a bond fund?

Postby Daffy » Fri Feb 01, 2013 3:34 am

letsgobobby wrote:I happily accept the 1% loss in my bond funds this month, since my stock funds were up, what, 6% in 31 days?


Not me. For me it's bad enough I have to watch equities gyrate the way they do the last thing I find tolerable is a TBM fund losing 1% in any given month. This is just another wake-up call that even bond index funds can and do lose money in a very quick period of time. As such, I'm about 75% done with migrating all my bond fund money into CD ladders and I Bonds. I plan on migrating the rest shortly. I'm semi-retired, so for me locking in principal and preserving capital is my main priority.
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Re: When is a bank CD safer than a bond fund?

Postby BrandonBogle » Fri Feb 01, 2013 4:02 am

FinancialDave wrote:
BrandonBogle wrote:
Sorry, I'm new to BogleHeads, so I could pick up on whether you were say for or against in my post while clearing the confusion of the thread. I agree that this shouldn't be used to protect against inflation. For her holdings, I'm still recommending she gets bonds. This would substitute the short term bond fund thought that she would be looking to tap into in the next two or so years. With such a short timeframe, stability is worth much to her. More info here (http://www.bogleheads.org/forum/viewtopic.php?f=1&t=109885). This would basically be 15% - 27% of her total holdings. Just got to see how TIPS compare to see if this would replace TIPS as well or coexist with them


Brandon,
I am just one of those a little concerned with the intermediate bond universe right now. I was just downloading a bunch of my portfolios from M* and notice most Intermediate bond funds are already down almost 1% just in Jan. Most people invest in these funds not knowing they can drop 10-20% pretty easily under the right conditions. It does look like you have a fairly conservative approach, but you do need to be in a position where you don't have to draw from the intermediate bond funds for up to at least 5 years, if you want to try and maintain the principal, so if you could get $60k-$70k in CD's or I-Bonds or a combination of the two she should be ok.

I would suggest to definitely pay off the car loan with some of the current Intermediate bond fund money -- this is a guaranteed 1.5% payback, which I doubt you will get from these, and even if you do it certainly is not guaranteed. Paying down debt is always a good guarantee. Then you may consider how much income would be freed up by paying off the mortgage. This is a little tougher decision, but here it looks like the guarantee is 2.75% -- it's not likely you will get this out of any of the bond funds in the next 3-5 years (pure guess on my part.) Once again its a guaranteed return.

That's about all I can comment on with the brief look I took.

fd


I don't mean to thread jack, so I won't go into too much detail here. Everything she has is in CDs right now and pretty much always has been. She started a 401k just before the 2000 crash and tried again just before the 2008 crash, so she's been very apprehensive about it all and it's taken lots of coaxing to convince her of a 40% stock/60% bond allocation when the big kahuna CD matures in two weeks. She has expenses for the next two years already covered, so everything would be for after two or three years.

With being so risk adverse, and just finding out the FI will allow penalty-free withdrawals from the CD, it's hard for her to say no to a 1.85% 4-year CD. The car is an option we can consider if nothing than 1.5% is available. But the mortgage is not. She is very underwater in it and fully expect it to disappear as a debt of her estate.

But back on topic, I'm very interested in learning others feelings about CDs instead of short-term bond funds. I'd expect length of investment to stretch out far enough for intermediates. Still trying to grasp TIPS.
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Re: When is a bank CD safer than a bond fund?

Postby z3r0c00l » Fri Feb 01, 2013 8:16 am

A person who apparently sells after a crash then "tries again" just as stock reach record highs probably should not have any say in how she invests at all or should not invest if they cannot be convinced to put this dangerous behavior to bed. I would rather she just keep her money in CDs for life than try to play the market in this way.

I think we have found something more dangerous than any other investment method; trying to time the market based on emotion.

If you get a CD at Ally you can get out at any time with minor fees in most cases.
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Re: When is a bank CD safer than a bond fund?

Postby john94549 » Fri Feb 01, 2013 9:12 am

Brandon, reading between the lines, it appears you are considering the PenFed IRA CD. Indeed, for those over 59 1/2, early withdrawal penalties are waived for partial withdrawals. This is not terribly onerous, since the definition of "partial" is any amount which does not bring the balance on the IRA CD below the minimum amount required to open an IRA CD of that term (without looking it up, I suspect $1000)*. I have two IRA CDs at PenFed and am in the "over 59 1/2" age cohort. While I have not done any partial withdrawals at PenFed, I have done two at StateFarmBank (which has basically the same exception for over 59 1/2-ers). This is a great "perk" and not widely available. The allowance for "partial withdrawal with no EWP" essentially morphs the IRA CD into a money market fund paying 1.85%. One caution: I do not know how long it takes PenFed to crank out a check. At StateFarmBank, both times, I had my funds within a week to ten days. YMMV.

For those over 70 1/2, different rules apply. As a general concept, withdrawals (partial or otherwise) are more readily available, and penalties less likely.

The NCUA insurance limit is $250,000.

Distribution (withdrawal) forms are available on-line, or by mail.

*Example. You open a 4-yr IRA CD. The minimum required to open such an IRA CD is (fill in the blank, I'll pick $1000). You buy a $100,000 IRA CD. You can request a "partial withdrawal" at any time during the term of up to $99,000. There would be no EWP. If you want it all out, standard EWP would apply. On the other hand, if you first take out $99,000 (partial; no EWP) and then, a month later, request the balance ($1000), the EWP would apply only to the $1000. At least that is how it was explained to me.
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Re: When is a bank CD safer than a bond fund?

Postby FinancialDave » Fri Feb 01, 2013 1:39 pm

I AGREE, don't take her CD money and put it in bonds, except I-bonds, she will not be happy!

At least until you see what happens over the next 4-5 years.

If you want to prove it to yourself, just take a small position like maybe $5,000 into what ever bond fund you plan to buy and watch it's total return over the next few years. Some longer term bond funds are already down 3% in Jan. --- not saying they can't go up short term, but the volatility is starting to pick up, which is not a good sign.

fd
Last edited by FinancialDave on Fri Feb 01, 2013 4:55 pm, edited 1 time in total.
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Re: When is a bank CD safer than a bond fund?

Postby BrandonBogle » Fri Feb 01, 2013 1:50 pm

FinancialDave wrote:I AGREE, don't take her CD money and put it in bonds, except I-bonds, she will not be happy!

At least until you see what happens over the next 4-5 years.

If you want to prove it to yourself, just take a small position like maybe $5,000 into what ever bond fund you plan to buy and watch it's total return over the next few years. Some longer term bond funds are already down 3% in Jan. --- not saying they can't go up short term, but the volatility is starting to pick up, which is not a good sign.

fd


I just started my rebalancing from 100% stock to 80/20. But I'm 30, so I have time to tolerate swings in the balance.

Can we move my specific concerns to their respective threads? I would hate to take away from the Op and the general discussion of CD vs Bonds with my discussion on how to allocate it for our specific portfolios.

My portfolio = http://www.bogleheads.org/forum/viewtopic.php?f=1&t=110026
Mom's portfolio http://www.bogleheads.org/forum/viewtopic.php?f=1&t=109885
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Re: When is a bank CD safer than a bond fund?

Postby Senin » Sat Feb 02, 2013 3:44 am

I too am worried. Are we in for a Bond Bubble. They have done remarkably well for the past few years. Too well. Of course the fed has kept them artificially low. That is not natural. At some point, they will explode. Is that safe? I don't think so. Right now I am very cautious of bonds. I sold all of my GNMAs. Now Im into Vanguard Interm-Term Tx-Ex Inv.
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Re: When is a bank CD safer than a bond fund?

Postby Bustoff » Sat Feb 02, 2013 10:05 am

Always. The CD is always safer.
Any other answer, opinion, or debate is specious.
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Re: When is a bank CD safer than a bond fund?

Postby dbr » Sat Feb 02, 2013 10:19 am

Senin wrote:I too am worried. Are we in for a Bond Bubble. They have done remarkably well for the past few years. Too well. Of course the fed has kept them artificially low. That is not natural. At some point, they will explode. Is that safe? I don't think so. Right now I am very cautious of bonds. I sold all of my GNMAs. Now Im into Vanguard Interm-Term Tx-Ex Inv.


If bonds are going to "explode" (whatever that means), how on earth is IT Tax Exempt bond fund supposed to be safer than GNMA or any other bonds or bond funds?
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Re: When is a bank CD safer than a bond fund?

Postby Call_Me_Op » Sat Feb 02, 2013 10:21 am

dbr wrote:
Senin wrote:I too am worried. Are we in for a Bond Bubble. They have done remarkably well for the past few years. Too well. Of course the fed has kept them artificially low. That is not natural. At some point, they will explode. Is that safe? I don't think so. Right now I am very cautious of bonds. I sold all of my GNMAs. Now Im into Vanguard Interm-Term Tx-Ex Inv.


If bonds are going to "explode" (whatever that means), how on earth is IT Tax Exempt bond fund supposed to be safer than GNMA or any other bonds or bond funds?


I agree with dbr - the statement by Senin makes little sense.
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Re: When is a bank CD safer than a bond fund?

Postby SpringMan » Sat Feb 02, 2013 10:55 am

It is inconvenient for people that hold their IRAs with Vanguard or any other brokerage or mutual fund firm to transfer their fixed income to a bank to take advantage of CDs. Brokered CDs sold by brokerages are a different beast. Their value goes up and down on the secondary market just like a bond. Currently we are 65% bond funds at Vanguard and Fidelity. Transferring IRA fixed income to a bank would allow FDIC backed CD purchases but at what cost? Banks often have annual charges for IRAs. I would lose our Flagship client status at Vanguard as well. I will stick to bond funds. For taxable accounts CDs make more sense though I don't use them.
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Re: When is a bank CD safer than a bond fund?

Postby investor1 » Sat Feb 02, 2013 11:49 am

I can see including CDs in your AA in or very close to retirement, but other than that, it would seem to be difficult to rebalance going forward with CDs. How would that be handled?
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Re: When is a bank CD safer than a bond fund?

Postby stevewolfe » Sat Feb 02, 2013 12:09 pm

investor1 wrote:I can see including CDs in your AA in or very close to retirement, but other than that, it would seem to be difficult to rebalance going forward with CDs. How would that be handled?


By holding stocks and bonds in your 401(k) (for example) and CD's in your IRA. Say 10% of your bonds in 401(k) for rebalancing would likely work.
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Re: When is a bank CD safer than a bond fund?

Postby Senin » Fri Feb 15, 2013 6:46 am

[Personal attack removed by admin LadyGeek]

Anything held artificially tends to explode. Look at the Dot Com-- artificially high. Look at the Zero Prime Housing Market-- artificially high. Now look at the Bond Market--- held artifically low. At some point, the value of bonds will crash.

IT Tax Exempt too, but at a slower rate than GNMA's.
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Re: When is a bank CD safer than a bond fund?

Postby Call_Me_Op » Fri Feb 15, 2013 7:58 am

Senin,

You are being overly-sensitive, when people are just trying to help. What I (and dbr) were getting at is that you sold GNMA (because of fear of a bond bubble) but then purchased Intermediate Tax Exempt - which is subject to the same bubble and (negative convexity aside) has an even greater interest rate sensitivity. Even if you consider the convexity issue, you have not materially reduced your risk because current duration of Int Tax Ex is higher, and you are now assuming some (albeit small) credit risk.
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Re: When is a bank CD safer than a bond fund?

Postby nisiprius » Fri Feb 15, 2013 8:46 am

Assuming that you actually have the right to "break" the CD--to pay the penalty and make an early withdrawal any time you like--then you can say flatly that CDs are safer than bond funds, period. What's unusual--perhaps unprecedented?--is that CDs have a return that is comparable to bond funds. Just as, for the first time I can ever remember, bank accounts are paying more than money market mutual funds.

There are two kinds of "risk" and CDs are safer by both measures.

First, Bank CDs carry FDIC deposit insurance; the FDIC like all human institutions is imperfect, but the FDIC insurance surely makes them safer than individual bonds, and probably safer than some unimaginable systemic event that might cause widespread defaults on many bonds.

Second, CDs do not experience interest rate risk. If you break the CD early, you pay a penalty. You know how big that is in advance. Nobody knows how high interest rates could go and thus nobody knows how much a bond fund could decline, but certainly a very rapid 1% interest rise is well within the range of the thinkable, meaning that an intermediate-term bond fund like Total Bond could (sort of temporarily) lose 5%, a short-term bond fund 2%. These are much higher than typical CD penalties. Furthermore, you can always avoid the penalty by holding the CD to maturity (just as you can avoid interest rate risk by holding an individual bond to maturity--but not a bond fund).

What's unusual, maybe unprecedented, is that currently CDs are paying amount that are comparable to bond funds. The bond funds always used to pay enough more that there was a clear reward-for-risk proposition. (Similarly, it's unprecedented in my experience that bank accounts are paying more than money market mutual funds)

E.g. Vanguard Total Bond SEC yield 1.54%; "our" local bank's 5-year CD 1.25%
Vanguard Short-Term Bond Index SEC yield 0.44%; vs. our bank's 2-year CD 0.80%
Vanguard Prime Money Market SEC yield 0.01%; our CHECKING ACCOUNT is paying 0.05%!
Senin wrote:Look at the Dot Com-- artificially high. Look at the Zero Prime Housing Market-- artificially high. Now look at the Bond Market--- held artifically low. At some point, the value of bonds will crash. IT Tax Exempt too, but at a slower rate than GNMA's.
I really wish that everyone would make a habit of quantifying comparisons. CDs are safer than bonds, bonds are safer than stocks--these are differences in kind, big differences.

Fine tuning adjustments by shifting between selected subsets of a fundamental asset class are small differences in degree. All the stuff about this kind of stocks are safer than that kind, this kind of bonds are safer than that kind--when it is clear that there really is a small but definite difference in risk, there's usually a fully corresponding difference in reward, too. And the "less risky" is more like a vague marketing claim, like one brand of alkaline battery lasting longer than another. Lithium batteries do last longer than alkaline, alkalines do last longer than traditional carbon-zinc, those are big, important differences. Duracell versus Energizer, who knows?

It's hard to compare a taxable and a tax-exempt fund, but
Image
$127,530.89 is 67% more than $76,239.63
and I have never personally been in a 67% tax bracket.

Meanwhile, by most measures including crude eyeball--yes, I deliberately selected this period--
Image
--the intermediate-term tax-exempt has shown bigger fluctuations than the GNMA, and has not shown dramatically lower drops in previous downturns.

So a statement that the intermediate-term tax-exempt fund is "less risky" is not an accurate statement about past behavior or risk in general, it's a forward-looking market-timing prediction about the near future.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
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Re: When is a bank CD safer than a bond fund?

Postby crowd79 » Fri Feb 15, 2013 10:10 am

For long term savings, like retirement, I recommend a mix of I and EE Bonds. I-Bonds keep your money from eroding due to inflation and EE-Bonds have the guarantee doubling in 20 years, or 3.53% return. If interest rates remain low for the next 3 years (1.5% average, hypothetically saying), then interest rates would have to average over 4.5% for the remaining 17 years to beat out the EE's doubling effect.
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Re: When is a bank CD safer than a bond fund?

Postby Tom_T » Fri Feb 15, 2013 11:51 am

crowd79 wrote:For long term savings, like retirement, I recommend a mix of I and EE Bonds. I-Bonds keep your money from eroding due to inflation and EE-Bonds have the guarantee doubling in 20 years, or 3.53% return. If interest rates remain low for the next 3 years (1.5% average, hypothetically saying), then interest rates would have to average over 4.5% for the remaining 17 years to beat out the EE's doubling effect.

20 years to get a 3.5% return on EE bonds? I'll take my chances with market rates.
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Re: When is a bank CD safer than a bond fund?

Postby Call_Me_Op » Fri Feb 15, 2013 12:13 pm

Tom_T wrote:
crowd79 wrote:For long term savings, like retirement, I recommend a mix of I and EE Bonds. I-Bonds keep your money from eroding due to inflation and EE-Bonds have the guarantee doubling in 20 years, or 3.53% return. If interest rates remain low for the next 3 years (1.5% average, hypothetically saying), then interest rates would have to average over 4.5% for the remaining 17 years to beat out the EE's doubling effect.

20 years to get a 3.5% return on EE bonds? I'll take my chances with market rates.


Really, it's 20 years to get a 100% return - and it's better than anything else you can get today with a guarantee.
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Re: When is a bank CD safer than a bond fund?

Postby john94549 » Fri Feb 15, 2013 12:33 pm

The main problem with EE bonds is the purchase limitation. That aside, the "doubling" effect at 20 years (not to mention the tax-deferral and freedom from state and local tax) makes the EE bond very tasty. The effective rate at 20 years is certainly more than one would currently receive on a 30-year Treasury.
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Re: When is a bank CD safer than a bond fund?

Postby Tom_T » Fri Feb 15, 2013 1:07 pm

john94549 wrote:The main problem with EE bonds is the purchase limitation. That aside, the "doubling" effect at 20 years (not to mention the tax-deferral and freedom from state and local tax) makes the EE bond very tasty. The effective rate at 20 years is certainly more than one would currently receive on a 30-year Treasury.

I just have a hard time accepting a deal that says "we will guarantee you a 3.5% return if you wait 20 years." That sounds good if we're in for 20 years of Japan-like conditions. Otherwise, not so good.
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Re: When is a bank CD safer than a bond fund?

Postby Call_Me_Op » Fri Feb 15, 2013 2:08 pm

Tom_T wrote:
john94549 wrote:The main problem with EE bonds is the purchase limitation. That aside, the "doubling" effect at 20 years (not to mention the tax-deferral and freedom from state and local tax) makes the EE bond very tasty. The effective rate at 20 years is certainly more than one would currently receive on a 30-year Treasury.

I just have a hard time accepting a deal that says "we will guarantee you a 3.5% return if you wait 20 years." That sounds good if we're in for 20 years of Japan-like conditions. Otherwise, not so good.


If rates rise, you can sell your EE bonds with little or no penalty and invest elsewhere. All in all, a pretty good deal IMHO.
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Re: When is a bank CD safer than a bond fund?

Postby tj » Fri Feb 15, 2013 5:04 pm

Call_Me_Op wrote:
Tom_T wrote:
john94549 wrote:The main problem with EE bonds is the purchase limitation. That aside, the "doubling" effect at 20 years (not to mention the tax-deferral and freedom from state and local tax) makes the EE bond very tasty. The effective rate at 20 years is certainly more than one would currently receive on a 30-year Treasury.

I just have a hard time accepting a deal that says "we will guarantee you a 3.5% return if you wait 20 years." That sounds good if we're in for 20 years of Japan-like conditions. Otherwise, not so good.


If rates rise, you can sell your EE bonds with little or no penalty and invest elsewhere. All in all, a pretty good deal IMHO.


There is certainly one phantom "penalty" and that is if you don't hold for the full 20 years, you are foregoing a ~1% from various online checking/savings accounts, for a 0.2% rate on EE Bonds. If rates go up, the variance between EE bonds and other safe deposits could increase. Or it might not.
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Re: When is a bank CD safer than a bond fund?

Postby Call_Me_Op » Fri Feb 15, 2013 5:33 pm

tj wrote:There is certainly one phantom "penalty" and that is if you don't hold for the full 20 years, you are foregoing a ~1% from various online checking/savings accounts, for a 0.2% rate on EE Bonds. If rates go up, the variance between EE bonds and other safe deposits could increase. Or it might not.


Indeed - but this is unlikely for most of us. If you are aware that the value of your EE bond is going to nearly double in a year or two, you are highly unlikely to sell it unless you have no other liquid cash.

Under most scenarios, you end up doing reasonably well with the EE bond.
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Re: When is a bank CD safer than a bond fund?

Postby mm9811 » Fri Feb 15, 2013 6:02 pm

At this time, with ultra low interest rates the EE Bonds are a "no brainer" only limitation is you have to hold for 1 year and 3mo interest penalty if you redeem before 5 years and of course the 10k limit. I don't see any justification for a bond fund unless you think interest rates are NOT going to rise anytime in the next 10years+. This is one of those times in history where we know the direction of future interest rates. The only question is when will they rise, not if.
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Re: When is a bank CD safer than a bond fund?

Postby Kevin M » Fri Feb 15, 2013 6:30 pm

SpringMan wrote:It is inconvenient for people that hold their IRAs with Vanguard or any other brokerage or mutual fund firm to transfer their fixed income to a bank to take advantage of CDs.

Perhaps inconvenient, but well worth it to me, as I have a large allocation to fixed income, and 2% for a 5-year non-brokered CD makes much more sense to me than bond funds with more risk and comparable or lower yields. 1% in an online bank makes more sense to me than 0% in a money market. I have done many partial IRA transfers from Fidelity and Vanguard to various online credit unions and online banks; once the account is open, it only takes one, fairly simple form to execute the transfer.

SpringMan wrote:Brokered CDs sold by brokerages are a different beast. Their value goes up and down on the secondary market just like a bond.
Exactly.

SpringMan wrote:Transferring IRA fixed income to a bank would allow FDIC backed CD purchases but at what cost? Banks often have annual charges for IRAs.

None of the banks or credit unions I use charge any fees. There's lots of competition out there.

SpringMan wrote:I would lose our Flagship client status at Vanguard as well.

That's worth considering. Have you calculated how much this would cost you?

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Re: When is a bank CD safer than a bond fund?

Postby jsl11 » Fri Feb 15, 2013 6:43 pm

If someone is in their 70s or 80s, getting a competitive rate on EE bonds after 20 years is not very attractive. What good is getting a good rate if you will not be alive to see it?
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Re: When is a bank CD safer than a bond fund?

Postby Kevin M » Fri Feb 15, 2013 6:59 pm

jsl11 wrote:If someone is in their 70s or 80s, getting a competitive rate on EE bonds after 20 years is not very attractive. What good is getting a good rate if you will not be alive to see it?
Jeff

The only reason I can think of is to benefit your heirs.

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