Bogleheads

[grok87]

http://www.financialsamurai.co....cr=800x600

Interesting article. He argues that one should always buy the CD with the highest yield even if it is long maturity. I hasten to add that he is not talking about brokerage cds which are often callable, but the regular bank/credit union cds. For those ones you can generally get your money out early and just lose 6 months or a years interest. I think the point is something like this:

Say you buy a 7 year CD yielding 4% now. (pen fed has one). If rates go up 3% then if that were are a marketable CD or treasury then the market value would have gone down by 18% (duration of about 6 years * 3% rate increase) so getting out by losing 4% interest (one year say) is cheap and you would then get to lock in 7% going forward. If rates drop 2% then you've locked in a great rate for a longer period.

cheers,
_________________
grok, CFA

[eurowizard]

Isnt this already priced into CD yields? Banks know they are at risk of being callable for 1 year penalty and thus consequently offer a reduced yield on the CDs they issue.

[nisiprius]

[Taylor Larimore]

[HueyLD]

[fluffyistaken]

True about the fine print but, as the OP stated, penalty of one year of interest is still a great deal on a 7-yr CD at 4% compared to an equivalent treasury. Here's PenFed's CD info, including early withdrawal penalties: https://www.penfed.org/pdf/acc....mcdisc.pdf

[fluffyistaken]

[rb313]

Unless there is a premium for jumbo, you'd probably want to couple this with buying multiple smaller units rather than one big one, allowing you to take 'some' cash out if you needed to.

[nisiprius]

[HueyLD]

[OAG]

Duplicate Post.
_________________
OAG=Old Army Guy. Retired from USA (US Army) in 1979.

[OAG]

I have been using FDIC/NCUA Insured CD's for over 30 years (mostly at Pentagon FCU and Capital One Bank, but also at Navy FCU an another Florida CU). I have always purchased the longest terms with the best rates - as long as 10 year terms (Capital One) but mostly 7 Year Terms. I NEVER cash out early. The average IR for the past 30 years has been 5.7%, or more. Currently we own about 45 CD's maturing over the next 6 years @ 5.74% (CD Ladder). I have not purchased any for the past year as I had another use for the excess cash. One nice benefit, which all of the above institutions offer, is the ability to take the accrued interest as cash if you need it, either on a current or past basis. So this allows for a much smaller "emergency fund".
_________________
OAG=Old Army Guy. Retired from USA (US Army) in 1979.

[dm200]

For various reasons, the various combinations of rates, compounding frequency, penalties, ability to withdraw early or not, availability of posted interest, etc. - the CD market (especially those issued directly and not brokered - is not "efficient" in the sense that some banks and credit unions offer some really good deals and others offer terrible deals.

[knowmad]

I find that CDs over 3 years are almost always a bad choice compared to short to medium term bond funds. Under 3 years they are a great safety net.

[grok87]

[grok87]

[grok87]

[bmb]

Talk about a backwards strategy! It's like buying only stocks that are overvalued.
If anything, you should lengthen the maturity when rates are historically high. For example, in the 1970s yields were over 15%. A 30 year bond would have been a nice investment. US inflation seldom persists for long, but deflation can hang around for decades.
Better yet, don't pretend you can predict rates and stick with 5-year maturities or less, 7 years max when yields look too attractive to pass up..

[Dale_G]

bmb: On the other hand, CD or bond rates are 15% only when inflation is going through the roof - so no one wants to buy fixed income.

15% bonds only look good in retrospect. What people did instead was buy their washing machines, driers and sofas now before prices went up.

I lived through the high inflation 70s. Working people kept zip in banks, bonds or CDs. Despite your statement that inflation seldom persists for long, the length of the persistence is unknowable at the time.

And how long will the present low interest rates persist? Please let us know, we'll adjust our CD maturities appropriately..

Dale
_________________
first we crawl, then we walk, then we run, later we use any available transportation

[knowmad]

[tfb]

I agree there is inefficiency in retail CDs. Close to best CD rates should always beat equivalent term Treasurys. However, interest rates don't "jump" overnight. They go up gradually. When to break the CD, pay penalty and reinvest becomes an interesting question.

Suppose you are in a 7-year 4% CD with a 6-month interest penalty. 1 year down the road, the 6-year CD gives 4.5%. Breaking it costs you 2% and it takes 4 years to breakeven. Do you do it or do you wait?
_________________
The Finance Buff

[rs2007]

Are we basically talking about CD laddering? Just get the longest CD like a 5 year every year, and one will matter each year, rinse, repeat.

[grok87]

[grok87]

[Financial Samurai]

Hi Guys,

Interesting discussion we've got here, and I've enjoyed reading all the good commentary and advice.

Just some thoughts:

* How can my strategy be backwards if it's a consistent strategy that is employed in high and low inflationary environments? The 10-yr yield is back down to 3.25% and it certainly doesn't seem like rates are going up too much despite all the monetary expansion b/c the Output Gap is still huge.

* Yields at particular maturation points are pretty efficient for the most part. Hence, so long as we have an upward sloping yield curve, who cares what inflation is... the market is baking it in already and paying accordingly!

* The money I recommend investing in CD's is money you don't ever plan to touch. Hence, you won't be paying a penalty to withdraw anyway!

* After 5 years, your BLENDED CD yield is 100% going to be higher than any CD yield strategy with shorter durations, and most certainly your savings yield.

Keep the discussion a live, and hope to see you guys at Financial Samurai one day!

Keigu,

Financial Samurai - "Slicing Through Money's Mysteries"

[azxcvbnm321]

Isn't the language of most CDs something like, the bank MAY allow you to withdraw you money, at which point you pay a penalty, but this is at the banks' discretion and they are under no obligation to give you access to your money before the term ends?

I know as a general practice banks allow customers to take out money early, they figure most people who do that really need the money and they don't want the bad PR of denying an old grandmother money to pay for her mother's funeral or something like that. But should people start to use their generosity and treat it as an option, then the bank might decide to get tough and not allow you to withdraw money. I can't imagine a bank, in a liquidity crunch, allowing customers to take money out early if they have any say in the matter at all.

Unless there is a law that forces banks to allow early redemption, I'd bet that the language in the CD will favor the bank and give the bank the final option of granting you early exit with penalty, or not.

[nisiprius]

[dm200]

To the best of my knowledge, the Truth In Savings disclosures from banks and credit unions will always state the conditions and penalties for early withdrawal. I have looked at a few and the wording on the ones I looked at is not a trick - they say there is a penalty for early withdrawal.

I do know some institutions have CDs where no early withdrawal is allowed (except perhaps for death).

[Fbone]

I find in my local CU that the spread between a 1yr and 5yr CD is so small that the penalty outweighs benefits. And they often have "special offers" that make the short term CDs a better deal.
Currently 1yr is 1.69%
2yr is 2.23
4yr is 2.72
5yr is 2.48
6yr is 2.28

[rb313]

[rb313]

Bumping this because I don't think any conclusion was come to. To me. a strategy of rolling CDs would do better than a strategy of buying long and cashing out for a higher rate in the environment of regularly rising rates. Not to predict interest, but I think the least likely scenario would be a big bump followed by many flat years, as in above example.

[Beth]

[grok87]

[nisiprius]

[G12]

Searching for places to park cash over the last 3 months has become challenging. INGdirect had a 1-year CD last week for 2.25% with a 90-day early withdrawal penalty or an online insured MMF with CapOne is paying 1.73%. Why would an investor consider buying a ST bond fund that will have a YTM less than half of what the average stated coupon rate is, short duration or not? I would prefer to sit on cash earning nothing compared to accepting a significant loss on a bond fund that will lose value when interest rates turn. Then I look at the 4.625% mortgage I have which probably has one more year of deductible itemized interest expense and think why not just pay it it off.

[Patchy Groundfog]

[dm200]

[Bob's not my name]

[spam]

I just created a 5 year CD ladder from brokered CD's in a large tax-advantaged 20 / 80 fixed-income account. I bought 1,2,3,4,and 5 year CDs with the same maturity date and the total represents 10% of this account. I hope to buy longer-term instruments when these mature. I did this for several reasons.

1) To protect this cash from me.
2) To help immunize this account against interest rate and market risk.
3) To harvest gains from bond funds that are now trading at historic highs.

I suspect that interest rates will begin to rise within the next 5 years, so I have taken a slightly pro-active position. I don't know what the most attractive instument will be down the road, CD's, TIPs, Treasuries, or Corporates, but I do know that this slice will hold individual issues held to maturity. After all, the Fed could raise interest rates BEFORE inflation resumes. Previously purchased TIPs would suffer, but new issues could could come with a very attractive coupon. For now, the best rates I could find are with the CD's, and I am happy to wait and see what develops.

I consider this decision to be more positional than predictive. I do hope to increase the term to 10 - 20 years as these mature, but I will take what I think is the best deal at the time.

Thats my plan, and I plan to stick to it.

[spam]

[stevewolfe]

[RobG]

Regarding the issue of redemption, I have bought/sold two CDs through Vanguard's brokerage services with absolutely no problems. Both times they were sold with a gain. I'm not sure why they aren't mentioned here.

For the last several years their CD rates have exceeded comparable treasuries and competitive with total bond market, even though they have shorter duration.

[hudson]

Vanguard brokered CD rates

Maturity Rate
3 month 0.20%
6 month 0.50%
9 month 0.85%
1 year 1.35%
18 month 1.85%
2 year 2.05%
3 year 2.50%
4 year 2.80%
5 year 3.10%


https://personal.vanguard.com/us/funds/bonds

[stevewolfe]

Wow - compared to the 1 year rate the current I-Bond looks like a good deal... it could draw 0 for the second 6 month period and still beat that rate...

[Bob's not my name]

Sure, but brokered CDs include a hidden commission for the broker*. My CU offers 1-year jumbo CDs at 2.25%. If I understand I-bonds correctly, you could make as little as 1.68% at the current rate if, as you suggest, the second 6-months dropped to zero. If the rate doesn't change, you could earn 3.36% minus the 3-month penalty for cashing early, or 2.52%. My CU matches that rate on an 18-month jumbo. Holding the I-bond for 18-months at a stable rate might yield 3.36% + 1.68% - 0.84% = 4.2% = 2.8% annualized.

So I-bonds compare favorably to short-term CDs, but it's not very compelling, and you're limited to $5,000 per year for I-bonds, so shouldn't you be buying them for the long term rather than as a substitute for 1-year CDs?

*Which is not to say brokered CDs are all bad -- you have more choice in banks and terms, you can sell on the secondary market if you need to, and you have the survivor's option.

[spam]

Bob's not my name wrote:

[Bob's not my name]

"Another benefit of brokered certificates of deposit, is that while the broker receives a commission for selling you a CD, it doesn't come out of your pocket. The bank pays the broker." That's what I meant by hidden. Just because Fidelity says you pay no fee doesn't mean a fee wasn't paid -- it's reflected in your interest rate. Brokered CDs are attractive because your broker can shop nationwide for the best rates, which would be a major hassle for you. However, the broker is of course making money on the deal. Broker's commissions on many fixed income vehicles have become more apparent at today's very low interest rates -- for example, a broker often charges 1% annually to put your money in a mutual fund, which is ridiculous when bond mutual funds are paying only a few percent.

[stevewolfe]

[hudson]

I-Bonds purchase limit per year:

5000 treasury direct and 5000 paper...total 10K
If married, you could purchase 10K for your wife.
The limit is 10K per social security number so you could also buy them for your children?

From Treasury Direct:
http://www.treasurydirect.gov/....ibonds.htm
Buying I Bonds through TreasuryDirect:
Sold at face value; you pay $50 for a $50 bond.
Purchased in amounts of $25 or more, to the penny.
$5,000 maximum purchase in one calendar year.
Issued electronically to your designated account.

Buying Paper I Bonds:
Sold at face value; i.e., you pay $50 for a $50 bond.
Purchased in denominations of $50, $75, $100, $200, $500, $1,000, and $5,000.
$5,000 maximum purchase in one calendar year.
Issued as paper bond certificates.

[grok87]