Why not 100% CD's?

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Bustoff
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Why not 100% CD's?

Post by Bustoff »

I'm beginning to believe that CD's may offer the best risk-adjusted reward for myself. Not sure if my risk tolerance is getting lower or it's just a transitional period, but I wanted get some feedback from the forum and make sure I'm not having a senior moment.

If you believe Vanguard's latest forecasts of future returns in their 2014 Economic and Investment Outlook, their models project 10-year, average real returns for a 60% stock/40% bond portfolio in the 3.1% -5.2% range.

As a retired investor with a low risk tolerance, five-year CD's paying 3% would put me right at the lower range of those models, but without the risk. And that's fine with me because I'm much more interested in downside protection rather than upside potential. I realize 5-year CD's are not being offered as we speak but there's a good chance that 3% is around the corner.

The prospect 100% CD's becomes a little more awkward on the taxable side of the portfolio. Not very efficient. But should I allow taxes to dictate my risk tolerance?
John3754
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Re: Why not 100% CD's?

Post by John3754 »

Bustoff wrote:If you believe Vanguard's latest forecasts of future returns in their 2014 Economic and Investment Outlook, their models project 10-year, average real returns for a 60% stock/40% bond portfolio in the 3.1% -5.2% range.

As a retired investor with a low risk tolerance, five-year CD's paying 3% would put me right at the lower range of those models, but without the risk.
False, Vanguard is forecasting a 3.1% -5.2% REAL return, whereas a CD yielding a 3% NOMINAL return would give you about a 0% REAL return.

The risk of being in 100% CDs with a current real return of 0% is if unexpected inflation shows up your purchasing power will be crushed.
dbr
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Re: Why not 100% CD's?

Post by dbr »

If you have enough money to support your retirement at that return in the face of possible inflation you could put everything in CD's. A concern would be to distribute the holdings accross enough banks to keep full FDIC coverage.

There aren't very many people who are so intolerant of volatility yet so immune to the cost of low returns without stocks or without having pensions and annuities for income as to make 100% CD's sensible. However, if your needs are minimal relative to your wealth and your inflation adjusted income needs are otherwise met, then it could be reasonable.

NB Note the above reply posted as I am typing.
asif408
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Re: Why not 100% CD's?

Post by asif408 »

If you've already got enough money, sure. Though to guarantee you keep up with unexpected inflation (as another poster mentioned) you might want inflation protected securities. If I was in retirement and had enough money I'd be 100% in I-bonds and individual TIPS. To me that would be an even lower risk than CDs.
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Re: Why not 100% CD's?

Post by dbr »

asif408 wrote:If you've already got enough money, sure. Though to guarantee you keep up with unexpected inflation (as another poster mentioned) you might want inflation protected securities. If I was in retirement and had enough money I'd be 100% in I-bonds and individual TIPS. To me that would be an even lower risk than CDs.
Very likely the OP should be asking why not 100% TIPS.
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Re: Why not 100% CD's?

Post by chaz »

Diversification?
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Sbashore
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Re: Why not 100% CD's?

Post by Sbashore »

John3754 wrote:
Bustoff wrote:If you believe Vanguard's latest forecasts of future returns in their 2014 Economic and Investment Outlook, their models project 10-year, average real returns for a 60% stock/40% bond portfolio in the 3.1% -5.2% range.

As a retired investor with a low risk tolerance, five-year CD's paying 3% would put me right at the lower range of those models, but without the risk.
False, Vanguard is forecasting a 3.1% -5.2% REAL return, whereas a CD yielding a 3% NOMINAL return would give you about a 0% REAL return.

The risk of being in 100% CDs with a current real return of 0% is if unexpected inflation shows up your purchasing power will be crushed.
I agree with this. There is no way to avoid all of risk if you want to preserve your purchasing power. If you have a low risk tolerance your AA should reflect that. Staying away from equities 100% though will just be trading one risk (volatility) for another (inflation risk).
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staythecourse
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Re: Why not 100% CD's?

Post by staythecourse »

Sbashore wrote:
John3754 wrote:
Bustoff wrote:If you believe Vanguard's latest forecasts of future returns in their 2014 Economic and Investment Outlook, their models project 10-year, average real returns for a 60% stock/40% bond portfolio in the 3.1% -5.2% range.

As a retired investor with a low risk tolerance, five-year CD's paying 3% would put me right at the lower range of those models, but without the risk.
False, Vanguard is forecasting a 3.1% -5.2% REAL return, whereas a CD yielding a 3% NOMINAL return would give you about a 0% REAL return.

The risk of being in 100% CDs with a current real return of 0% is if unexpected inflation shows up your purchasing power will be crushed.
I agree with this. There is no way to avoid all of risk if you want to preserve your purchasing power. If you have a low risk tolerance your AA should reflect that. Staying away from equities 100% though will just be trading one risk (volatility) for another (inflation risk).
Agree 100%. There is no free lunch. Either one chooses volatility on one side (100% equity) or inflation risk (100% fixed income) on the other side or some point in between. Only exception may be TIPS, but its only been around since 1997 and have not seen it in action during high inflationary periods.

Good luck.
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Bustoff
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Re: Why not 100% CD's?

Post by Bustoff »

John3754 wrote: The risk of being in 100% CDs with a current real return of 0% is if unexpected inflation shows up your purchasing power will be crushed.

Thanks John. But let me ask you this, if inflation became an issue, wouldn't CD rates be rising as well. Stocks are no guarantee against inflation. Rising rates would crush bond funds. If my withdrawal rate is only 2.5% and there are no legacy concerns, how am I getting crushed.

One other thing. Grandpa and Grandma never saw a stock or bond in their life. Grandpa made very little money as a barber and she never worked. They lived into their mid 80's doing great on SS and CD's.
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Re: Why not 100% CD's?

Post by letsgobobby »

Bustoff wrote:
John3754 wrote: The risk of being in 100% CDs with a current real return of 0% is if unexpected inflation shows up your purchasing power will be crushed.

Thanks John. But let me ask you this, if inflation became an issue, wouldn't CD rates be rising as well. Stocks are no guarantee against inflation. Rising rates would crush bond funds. If my withdrawal rate is only 2.5% and there are no legacy concerns, how am I getting crushed.

One other thing. Grandpa and Grandma never saw a stock or bond in their life. Grandpa made very little money as a barber and she never worked. They lived into their mid 80's doing great on SS and CD's.
many people live very well on just the SS part. If that suffices for your needs/lifestyle, and you are very risk-intolerant, then you should probably have all of your portfolio in something extremely low risk - I would say I bonds and TIPS over short-term CDs, but either way, far less risky than stocks.
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Leif
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Re: Why not 100% CD's?

Post by Leif »

I think CDs are good for your short term (< 5 years) money, perhaps even up to < 10 years. I'm building a CD ladder now for retirement to take me up to 70. I don't have the downside risk with raising interest rates that I have in bonds. If you get a "good" CD you can break it and reinvest with a small penalty should rates raise quickly.

I could not imagine 100% CDs. Even if you are extremely conservative I think you should have at least 20% in equities.
Last edited by Leif on Fri Sep 26, 2014 10:42 am, edited 1 time in total.
technovelist
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Re: Why not 100% CD's?

Post by technovelist »

Bustoff wrote:
John3754 wrote: The risk of being in 100% CDs with a current real return of 0% is if unexpected inflation shows up your purchasing power will be crushed.

Thanks John. But let me ask you this, if inflation became an issue, wouldn't CD rates be rising as well. Stocks are no guarantee against inflation. Rising rates would crush bond funds. If my withdrawal rate is only 2.5% and there are no legacy concerns, how am I getting crushed.

One other thing. Grandpa and Grandma never saw a stock or bond in their life. Grandpa made very little money as a barber and she never worked. They lived into their mid 80's doing great on SS and CD's.
If there is a hyperinflation or a lengthy period of high inflation, it is unlikely that you will be compensated for your loss of purchasing power by rising interest rates, especially after tax effects.

A reasonable proportion of your assets in gold would probably help in that situation, which is not as unlikely as a lot of people think.
In theory, theory and practice are identical. In practice, they often differ.
dbr
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Re: Why not 100% CD's?

Post by dbr »

Bustoff wrote:
John3754 wrote: The risk of being in 100% CDs with a current real return of 0% is if unexpected inflation shows up your purchasing power will be crushed.

Thanks John. But let me ask you this, if inflation became an issue, wouldn't CD rates be rising as well. Stocks are no guarantee against inflation. Rising rates would crush bond funds. If my withdrawal rate is only 2.5% and there are no legacy concerns, how am I getting crushed.

One other thing. Grandpa and Grandma never saw a stock or bond in their life. Grandpa made very little money as a barber and she never worked. They lived into their mid 80's doing great on SS and CD's.
A 2.5% withdrawal rate is probably at the edge below which it really doesn't matter at all how you invest in so far as outliving your money. You mention how well Grandpa and Grandma did on SS and CDs. A good question would be how much income you have (as a fraction of need) in SS and other inflation indexed annuities. It is still also a question what drives you to prefer CDs when TIPS explicitly insure against inflation at comparable real return. It is also a question what it is that drives you against holding any stocks at all. If this is just a hypothetical question, then the answer is that, sure, you could hold only CD's and might well be fine at that withdrawal rate. The answer is also that you would not be more fine than several other ways to do this. Please go back to the issue of how much inflation indexed income you have outside the portfolio.

NB I will not be watching this thread for awhile.
supernova
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Re: Why not 100% CD's?

Post by supernova »

Where are you finding 3% 5-year CD rates? Best I can find is 2.34%
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Re: Why not 100% CD's?

Post by Call_Me_Op »

100% in anything is the wrong answer.
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leonidas
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Re: Why not 100% CD's?

Post by leonidas »

In the 80's and 90's CD's did have a positive real return and your case for 100% CDs would have been stronger even though I do believe that for true inflation protection having a bit of Equities in your portfolio is prudent.
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ogd
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Re: Why not 100% CD's?

Post by ogd »

Bustoff: historically, the minimum risk position has not been 0% stocks, but 25%-30%. Adding these not only improved returns but actually reduced risk. The reasons are many: rebalancing bonus, interest rate risk, inflation.

And this is before taxes; if you add those into the picture the relatively decent behaviour under inflation of short-term bonds, breakable CDs (whose continued existence at relatively low withdrawal penalties is by no means guaranteed) and even TIPS takes a big hit.
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Re: Why not 100% CD's?

Post by letsgobobby »

also if you are that risk averse and willing to take such a low rate of return, why not annuitize a portion of your portfolio?
technovelist
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Re: Why not 100% CD's?

Post by technovelist »

letsgobobby wrote:also if you are that risk averse and willing to take such a low rate of return, why not annuitize a portion of your portfolio?
Agreed.
In theory, theory and practice are identical. In practice, they often differ.
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Re: Why not 100% CD's?

Post by trueblueky »

See http://theRetirementCafe.blogspot.com for a discussion of various retirement income strategies. I'd say the one most discussed in this forum is systematic withdrawal.

You might appreciate the "floor and upside" strategy discussion, which that author favors. That strategy involves ensuring a floor amount of monthly income, plus investing for possible upside. The floor could come from pension, SS, TIPS ladder, SPIA or a combination. CDs do not by themselves make a reliable floor, for the reasons discussed here by others.
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Re: Why not 100% CD's?

Post by Kevin M »

What is your current AA?

My preference is to make AA changes gradually. Although I now have about 50% of my portfolio in direct CDs, I got here by gradually selling bond funds as rates dropped and prices rose, and using the proceeds to buy CDs. I also have been buying CDs when rebalancing out of stocks. I plan on continuing to do so until the risk/return tradeoff warrants a shift in strategy. At some point I very well may start shifting from CDs back into nominal bonds and/or TIPS, but not at current interest rates.

Although I still have a 30% allocation to stocks, I might not own any stocks if my portfolio were smaller. I'm kind of in the Liability Matching Portfolio camp for retirees, and I think in the current low interest-rate/low-inflation environment, direct CDs are an excellent choice for the LMP. I still like to own some bond funds for higher yields, liquidity, and some exposure to term risk and credit risk, but I don't think I'd be uncomfortable with 100% CDs in the current environment. I consider the small early withdrawal penalty (EWP) of good direct CDs as reasonable protection against unexpected inflation, similar to that of very short-term bonds.

Although if your portfolio is large it doesn't have much impact, maxing your I Bond purchases each year helps with inflation protection. With a living trust, you can buy $20K per year (or $30K/year for a couple with a living trust).

I hold CDs in both taxable and tax-advantaged accounts. Unless your marginal tax rate is higher than 25%, the after-tax yield of a good direct CD is comparable to (or perhaps higher than) that of a national tax-exempt bond fund, especially if you look at SEC yields. Even if the after-tax yield is somewhat lower, a direct CD has much less risk, so may still be the better choice when you trade off risk and expected return. I am leaning toward decreasing my tax-exempt bond fund holdings and increasing my taxable CD holdings, especially if we see a 3% CD deal in the next couple of months. Someone just posted about a 2.5% 5-year CD, so things seem to be moving in that direction.

Kevin
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Re: Why not 100% CD's?

Post by Bustoff »

dbr wrote:It is still also a question what drives you to prefer CDs when TIPS explicitly insure against inflation at comparable real return
I do not understand TIPS sufficiently (not for a lack of trying) to invest in them. I do not understand the meaning or the measurement "unexpected inflation". Even if I did understand, I don't have enough faith in those responsible for the measurement.

I do not understand the idea behind allocating only a portion of one's portfolio in TIPS, even though the entire portfolio is subject to inflation. For instance, Target Retirement Income is 70% fixed income, yet only 16.7% is allocated to TIPS. What's protecting the other 83% of the portfolio, stocks and nominal bonds?
dbr wrote:It is also a question what it is that drives you against holding any stocks at all.
Explain how the possibility of an extra 2% upside return in a 60/40 portfolio is worth risking 30% of downside?
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Re: Why not 100% CD's?

Post by linenfort »

supernova wrote:Where are you finding 3% 5-year CD rates? Best I can find is 2.34%
around the corner, said the OP.
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Re: Why not 100% CD's?

Post by gerrym51 »

a 3 percent 5 year cd is not just around the corner. rates have been stagnant-with a few 'special rate teasers' occuring -for about a year
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Re: Why not 100% CD's?

Post by Bustoff »

John3754 wrote: The risk of being in 100% CDs with a current real return of 0% is if unexpected inflation shows up your purchasing power will be crushed.
These kind of broad statements might be more convincing if there were numbers directly correlated to the assertions.
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Bustoff
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Re: Why not 100% CD's?

Post by Bustoff »

chaz wrote:Diversification?
In a distribution portfolio, diversification offers little protection against sequence of return loss.
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Bustoff
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Re: Why not 100% CD's?

Post by Bustoff »

Sbashore wrote: If you have a low risk tolerance your AA should reflect that. Staying away from equities 100% though will just be trading one risk (volatility) for another (inflation risk).
Sbashore - I appreciate the thought, but would you not agree that at a low enough withdrawal rate, allocation matters little?
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Bustoff
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Re: Why not 100% CD's?

Post by Bustoff »

staythecourse wrote: Either one chooses volatility on one side (100% equity) or inflation risk (100% fixed income) on the other side or some point in between.

Good luck.
I agree. Which choice poses more risk in distribution portfolio?
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Re: Why not 100% CD's?

Post by linenfort »

How about:
50% short-term CDs + 50% TIPS or
50% short-term CDs + 50% gold?

EDIT: too much gold. How about:

50% CDs + 35% TIPS + 15% in gold?
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Re: Why not 100% CD's?

Post by Bustoff »

technovelist wrote: If there is a hyperinflation or a lengthy period of high inflation, it is unlikely that you will be compensated for your loss of purchasing power by rising interest rates, especially after tax effects.

A reasonable proportion of your assets in gold would probably help in that situation, which is not as unlikely as a lot of people think.
That is a lucid, intelligent, well thought-out objection.
Overruled. :D
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Re: Why not 100% CD's?

Post by hudson »

Bustoff wrote:I'm beginning to believe that CD's may offer the best risk-adjusted reward for myself.
As a retired investor with a low risk tolerance, five-year CD's paying 3% would put me right at the lower range of those models
I vote yes to 100% CDs. I like what Groucho said about treasuries: http://books.google.com/books?id=jIW612 ... es&f=false

I read the other contributions and believe that they give good advice...but it's up to you. If you don't sleep well with 20% stocks...don't go there. Go with 100% safety. Of course, keep doing your homework...take your time. Keep asking questions...as I know you will.
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Re: Why not 100% CD's?

Post by Dandy »

I'm a fan of using a CD ladder as a decent part of my retiree fixed income allocation. I would not advocate 100% or even near 100% allocation to CDs. But 20 to 25% seems good to me as a early retiree with about a 60% fixed income allocation.
But I also have allocations to TIPS and short and intermediate bond funds. So 20% CD ladder, 20% TIPs and 20% Total Bond (and/or Intermediate tax free) seems a good option for a 60% fixed income allocation. Just keep in mind that interest rates are likely to rise and while 3% looks good today it might not look so good 2 years from now.

Or, if you think you have a bit more than you need to fund a nice retirement then Wm Bernstein's idea of having 20 to 25 years of the anticipated portfolio drawdown in "safe" products makes sense. That would include CDs, short term bond funds and similar products. Then you will have less concern about interest rate and market swings. You could invest any excess (and I would suggest you have some excess) in products with more risk (and return). Having two portfolios (even if it is just mental segregation), one that secures the retirement and is "safe" and the other that is excess and might be used for growth, emergencies etc to me is better than saying I have a conservative allocation of 40% equities.

Each fixed income product has pros and cons - CDs provide protection from default and a bit more yield than most other investments that are default free. CDs also don't behave like the bond market in that there are often special rates with a bank desires to attract deposits e.g. last year Pen Fed 5 yr CD at 3% what much higher than the next highest bank.

Bank CDs have an interest penalty if redeemed early and it may be possible for them to delay or refuse early redemption requests. Brokerage CDs depend on finding a buyer and may pay less or more than the face amount. Since there is a strong possibility of rising interest rates, selling before maturity is likely to be at a loss. Also, brokerage CDs distribute the interest so you need to reinvest it. If a bank defaults on your CD you may not get the same interest rate from the assuming bank. So it is best to assume you will hold the CDs till maturity. Bonds and bond funds have more liquidity.

If you are using the fixed income portion of your portfolio for stability then CDs provide that to the extent you hold them to maturity.
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Re: Why not 100% CD's?

Post by Sbashore »

Bustoff wrote:
Sbashore wrote: If you have a low risk tolerance your AA should reflect that. Staying away from equities 100% though will just be trading one risk (volatility) for another (inflation risk).
Sbashore - I appreciate the thought, but would you not agree that at a low enough withdrawal rate, allocation matters little?
Yes I would agree. As others have said, there are many other factors that go into managing a portfolio in the distribution phase. As I mentioned if you're willing to trade volatility risk for inflation risk, and if the risk shows up, you can't be harmed because of other factors (portfolio size, other income, withdrawal rate etc.) then I'd say go for it. Don't take a risk that bothers you, especially if you don't need to. I was answering your point in your original post regarding "best risk-adjusted reward for myself". You based your conclusion on a lot of predictions about the future that of course can't be known and should not be taken as fact. If your definition of best risk-adjusted reward is to eliminate all equity risk and expose yourself to a large amount of inflation risk then you have the answer. If you just want to dampen down the volatility some, then the answer may include an equity component.
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Bustoff
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Re: Why not 100% CD's?

Post by Bustoff »

I truly appreciate the comments and suggestions.

I am really questioning my entire IPS lately. Eliminating as much risk as possible has been the dominating thought.
Some of you have pointed out that inflation erodes purchasing power. I think equating inflation risk to equity risk is a specious proposition. At least in the context of a distribution portfolio with a 2.5% WR.

So starting with the premise that my risk tolerance calls for a 30/70 stock bond portfolio, I have concluded that the return of CD's currently makes more sense than bond funds, at least for the foreseeable future. We will still contribute the annual limit to i-bonds, just as an experiment.

The more difficult question is whether the low expected return on the remaining 30% equity allocation is worth the risk. And I can't see it protecting the other 70% of the portfolio against inflation.
Thus, my thought process (unsound as it may be) with regard to eliminating the 30% in equities in a nutshell is that the potential inflation protection isn't worth the risk and the extra return on 30% isn't worth the risk.

PS - Please advise if there is any literature or analysis demonstrating that the risk of holding 30% equities provides inflation protection to the extent that it outweighs the risk of inflation on the other 70%.

Thanks again !
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Re: Why not 100% CD's?

Post by Seattlenative »

Dandy wrote: Bank CDs have an interest penalty if redeemed early and it may be possible for them to delay or refuse early redemption requests. Brokerage CDs depend on finding a buyer and may pay less or more than the face amount. Since there is a strong possibility of rising interest rates, selling before maturity is likely to be at a loss. Also, brokerage CDs distribute the interest so you need to reinvest it. If a bank defaults on your CD you may not get the same interest rate from the assuming bank. So it is best to assume you will hold the CDs till maturity. Bonds and bond funds have more liquidity......If you are using the fixed income portion of your portfolio for stability then CDs provide that to the extent you hold them to maturity.
If an investor wants to buy CDs directly from a bank or CU, be sure to read the CD contract carefully. In many cases, the actual CD language does not specify the "early withdrawal penalty". It also may allow the bank to refuse to allow an early withdrawal of funds on a CD. While the bank may advise you regarding the current early withdrawal penalty (EWP), the actual EWP amount is subject to change in the future at the bank's discretion. This is because banks and CUs are now facing stricter capitalization requirements by regulators, and "time deposits" are classified as "core capital" on the bank's books.

As for brokered CDs: if you decide to sell early, the resale value of your CD can fluctuate up-and-down like a bond, so you could lose principal, and there is a brokerage commission. For a retiree seeking income from CDs, many (but not all) brokered-CDs only pay interest semi-annually, while most CDs issued directly from the bank offer monthly interest payments. Above all else, investing in long-term CDs exposes an investor to significant inflation-related loss of purchasing power.
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Bustoff
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Re: Why not 100% CD's?

Post by Bustoff »

Kevin M wrote:What is your current AA?

My preference is to make AA changes gradually. Although I now have about 50% of my portfolio in direct CDs, I got here by gradually selling bond funds as rates dropped and prices rose, and using the proceeds to buy CDs. I also have been buying CDs when rebalancing out of stocks. I plan on continuing to do so until the risk/return tradeoff warrants a shift in strategy. At some point I very well may start shifting from CDs back into nominal bonds and/or TIPS, but not at current interest rates.

Although I still have a 30% allocation to stocks, I might not own any stocks if my portfolio were smaller. I'm kind of in the Liability Matching Portfolio camp for retirees, and I think in the current low interest-rate/low-inflation environment, direct CDs are an excellent choice for the LMP. I still like to own some bond funds for higher yields, liquidity, and some exposure to term risk and credit risk, but I don't think I'd be uncomfortable with 100% CDs in the current environment. I consider the small early withdrawal penalty (EWP) of good direct CDs as reasonable protection against unexpected inflation, similar to that of very short-term bonds.

Although if your portfolio is large it doesn't have much impact, maxing your I Bond purchases each year helps with inflation protection. With a living trust, you can buy $20K per year (or $30K/year for a couple with a living trust).

I hold CDs in both taxable and tax-advantaged accounts. Unless your marginal tax rate is higher than 25%, the after-tax yield of a good direct CD is comparable to (or perhaps higher than) that of a national tax-exempt bond fund, especially if you look at SEC yields. Even if the after-tax yield is somewhat lower, a direct CD has much less risk, so may still be the better choice when you trade off risk and expected return. I am leaning toward decreasing my tax-exempt bond fund holdings and increasing my taxable CD holdings, especially if we see a 3% CD deal in the next couple of months. Someone just posted about a 2.5% 5-year CD, so things seem to be moving in that direction.

Kevin
Wish I possessed your ability to articulate so eloquently.
My current AA is 30/70.
staythecourse
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Re: Why not 100% CD's?

Post by staythecourse »

Bustoff wrote:
staythecourse wrote: Either one chooses volatility on one side (100% equity) or inflation risk (100% fixed income) on the other side or some point in between.

Good luck.
I agree. Which choice poses more risk in distribution portfolio?
Great question. I would probably have to say it depends. The factors on the volatility side would be how much "cushion" do you have between living expenses and the size of the portfolio and on the inflation risk side how long, i.e. years of a withdrawal are u expecting. The uncertainty is what makes investing "interesting" in the distribution phase.

I have advocated at least a two bucket approach for years. One bucket to hold 5-10 yrs. of principal stable assets (the amount depending on your risk tolerance for loss) and the second bucket in diversified equities. That, in my opinion, should be how you set your asset allocation in withdrawal and not "I feel like 30/70 or 50/50". This way your asset allocation deals with your specifics, i.e. living expenses.

Good luck.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle
john94549
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Re: Why not 100% CD's?

Post by john94549 »

My wife and I did basically what you are proposing, albeit from a different direction. As noted in another thread, I set a target for enough in FI alone (tilted heavily to CDs in a ladder) to fund retirement, above-and-beyond other sources of income. Equities are now either the gravy or the gruel on top. Our AA is roughly 40/60 (equities/fixed-income). We are both 67, and are not yet withdrawing from principal.
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Sbashore
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Re: Why not 100% CD's?

Post by Sbashore »

The cumulative rate of inflation from 1970-1979 was 87.1 % (US Inflation Calculator using Gov't CPI figures)

http://www.usinflationcalculator.com/

If you're convinced that comparing equity volatility risk to inflation risk is specious for your situation I certainly hope you're right. Guess we'll find out. :happy

I'm retired too, and in my opinion I'm happy to expose a portion of my assets to equity risk to avoid a possible repeat of what happened in the 70's. Or even a less severe occurrence. Lost purchasing power is pretty much permanent, at least historically. Equity declines not so much. Yes they can look permanent if they extend over the period of your remaining lifetime, but that's why we choose a prudent asset allocation. Who knows what the future holds. Of course we all have different situations.
Steve | Semper Fi
ArthurO
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Re: Why not 100% CD's?

Post by ArthurO »

I don't think historically 100% CDs gave the best return, I think 20% equities and 80% fixed did better in both returns and risk, therefore if my portfolio reaches critical mass of enough monthly income for me to support myself I will go 20%/80% equities/CDs.

I think the argument that inflation will eat into purchasing power of CD money is seriously flawed, although that fact might be the truth, the loss of the purchasing power is nothing compared to the 50% market drop where you will loose both purchasing power and principle.

Therefore, to suggest that one should get more equities and less CDs because if inflation hits CDs will loose purchasing power is flawed and can be counteracted quite powerfully with the statement, "If I go more equities and less CDs i will protect my purchasing power, until the market crashes and I loose the chunk of principle".

I am happy loosing purchasing power and keeping principle in tact, thank you very much... but that's after I retire, and that is still way way in distant future, for me anyway.

And market loses can be permanent also, just look at Japan... I know that's why we have international, but who says the same thing that happened in Japan cannot happen in the world, noone knows the future, that's why I like averages, that's the best guide, it is 20/80 allocation for me in retirement... and let the dice fall where they fall
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Toons
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Re: Why not 100% CD's?

Post by Toons »

100% in Certificates of Depreciation? No thanks :happy
"One does not accumulate but eliminate. It is not daily increase but daily decrease. The height of cultivation always runs to simplicity" –Bruce Lee
john94549
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Re: Why not 100% CD's?

Post by john94549 »

Toons wrote:100% in Certificates of Depreciation? No thanks :happy
Too funny. Never heard that before. As my deceased Aunt used to say, you've had "tee-many mar-toonies."
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Re: Why not 100% CD's?

Post by Toons »

john94549 wrote:
Toons wrote:100% in Certificates of Depreciation? No thanks :happy
Too funny. Never heard that before. As my deceased Aunt used to say, you've had "tee-many mar-toonies."
:sharebeer :sharebeer
"One does not accumulate but eliminate. It is not daily increase but daily decrease. The height of cultivation always runs to simplicity" –Bruce Lee
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Kevin M
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Re: Why not 100% CD's?

Post by Kevin M »

Bustoff wrote: My current AA is 30/70.
OK, so same as mine.

Have you evaluated your risk tolerance in terms of ability, willingness and need to take risk? Using that framework, your posts make it sound like like your willingness to take risk may be decreasing. It also seems that perhaps you don't have the need to take much (any?) equity risk. You may have the ability to take some equity risk, which led you to the 30/70 allocation.

Since need to take risk and ability to take risk tend to push risk tolerance in opposite directions, perhaps it's OK to let your decreasing willingness to take risk guide you to a less risky portfolio. Perhaps we're in similar situations, in that we are likely to be OK with some stocks or no stocks. I still like holding some stocks, but have been considering selling portions of some of my riskier holdings and allowing my allocation to drift closer to 25/75. After all, large stock gains and moderate bond gains in the last few years have lowered my need to take risk even further.

For those of us with the flexibility to do so, good CDs seem like a fixed income no-brainer to me. With a 5-year treasury yielding 1.8%, a 5-year, federally-insured CD yielding 2.3% or more provides significantly more yield and the same credit risk, and a direct CD with good early withdrawal terms provides much less term risk. Even without the good early withdrawal terms, the CD is a better deal for the retail investor. A nominal treasury security of the same maturity is the fair comparison for a CD, since any other nominal bond providing a higher yield has more risk.

People with concerns about early withdrawal terms being changed or allowing the bank/CU to deny early withdrawals should maintain sufficient liquidity to not depend on early withdrawals. Building up your CD position over time results in a ladder of sorts, which helps with the liquidity issue. I started moving into direct CDs about four years ago, so I essentially now have a bunch of 1-year CDs earning 2.4% or more. High-yield savings accounts, reward checking accounts, I Bonds, and bond funds, (and stocks, if you want) can be used to provide the additional liquidity.

I'm crossing my fingers and hoping for another outstanding PenFed CD deal in the next few months. Seeing the post today about a 2.5% 5-year CD was a good sign.

Kevin
If I make a calculation error, #Cruncher probably will let me know.
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MossySF
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Re: Why not 100% CD's?

Post by MossySF »

The higher your savings rate is, the less return you need. At some threshold, 0% real is just fine -- plenty of immigrants have followed this route with 100% CDs. At another threshold, 0% nominal will work also -- see stories of people burying their cash around the house. And at another threshold, you could lose all your money -- see Great Depression stories.

If you want to reduce your risk, first examine whether your portfolio w/ 0% real return can support your expected expenses. If it can, go for it!
abyan
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Re: Why not 100% CD's?

Post by abyan »

Although if your portfolio is large it doesn't have much impact, maxing your I Bond purchases each year helps with inflation protection. With a living trust, you can buy $20K per year (or $30K/year for a couple with a living trust).
KevinM, I'd read some others comments in earlier posts, from like 2011, talking about this same idea of using a Living Trust to buy more ibonds per year than a married couple could normally buy. I've been googling and I can't find anything on this. I'm looking to put some of my parents' fixed income in ibonds, and they have a revocable living trust. I'd love to be able to buy more than simply $10k per person per year, and $5k per joint tax return as a refund. Do you have anything more on this?

Thanks!
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The529guy
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Re: Why not 100% CD's?

Post by The529guy »

abyan wrote:
Although if your portfolio is large it doesn't have much impact, maxing your I Bond purchases each year helps with inflation protection. With a living trust, you can buy $20K per year (or $30K/year for a couple with a living trust).
KevinM, I'd read some others comments in earlier posts, from like 2011, talking about this same idea of using a Living Trust to buy more ibonds per year than a married couple could normally buy. I've been googling and I can't find anything on this. I'm looking to put some of my parents' fixed income in ibonds, and they have a revocable living trust. I'd love to be able to buy more than simply $10k per person per year, and $5k per joint tax return as a refund. Do you have anything more on this?

Thanks!
Try here:
http://www.treasurydirect.gov/indiv/pla ... stform.htm
http://www.treasurydirect.gov/indiv/pla ... stsq_a.pdf
http://www.treasurydirect.gov/indiv/hel ... rnMore.htm
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Bustoff
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Re: Why not 100% CD's?

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Bustoff
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Re: Why not 100% CD's?

Post by Bustoff »

Sbashore wrote:The cumulative rate of inflation from 1970-1979 was 87.1 % (US Inflation Calculator using Gov't CPI figures)

If you're convinced that comparing equity volatility risk to inflation risk is specious for your situation I certainly hope you're right. Guess we'll find out. :happy
Well let's be fair. Take a look at equity returns from 1970-1979. I think CD's were a much better inflation hedge than stocks for the same time period. :sharebeer
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Sbashore
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Re: Why not 100% CD's?

Post by Sbashore »

Bustoff wrote:
Sbashore wrote:The cumulative rate of inflation from 1970-1979 was 87.1 % (US Inflation Calculator using Gov't CPI figures)

If you're convinced that comparing equity volatility risk to inflation risk is specious for your situation I certainly hope you're right. Guess we'll find out. :happy
Well let's be fair. Take a look at equity returns from 1970-1979. I think CD's were a much better inflation hedge than stocks for the same time period. :sharebeer
My apologies for picking a time period that failed to make my point. It was not my intent to make an "unfair" comparison.
Steve | Semper Fi
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