CDs & Savings as a substitute for bonds or bond funds

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pfb3326
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CDs & Savings as a substitute for bonds or bond funds

Post by pfb3326 » Sun Jan 14, 2018 9:17 pm

Are CDs and savings accounts acceptable alternatives to bonds or bond funds for the fixed income portion of a portfolio? This would seem reasonable to me at times of rising rates when you have about a ten year horizon or am I missing something? Thanks.

RRAAYY3
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Re: CDs & Savings as a substitute for bonds or bond funds

Post by RRAAYY3 » Sun Jan 14, 2018 9:22 pm

It’s what I do ... because I don’t see the point in having the “safe” portion of my assets being in something that can actually decline

All while buying extremely liquid and easily able to buy the next dip ...

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Kevin M
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Re: CDs & Savings as a substitute for bonds or bond funds

Post by Kevin M » Sun Jan 14, 2018 9:47 pm

Yes.

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mjb
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Re: CDs & Savings as a substitute for bonds or bond funds

Post by mjb » Sun Jan 14, 2018 9:57 pm

It is called "fixed income" for a reason. CD's and bank accounts can usually fetch better yields at equal risk to Treasuries for durations up to 5 years. The wiki has more on this on a few pages.

I personally use a mix of high yield bank accounts, CD'S, Muni funds, and taxable bonds depending on intended need and location.

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Re: CDs & Savings as a substitute for bonds or bond funds

Post by Tyler Aspect » Sun Jan 14, 2018 10:02 pm

I think part of this story of CD being safer than bond funds is a subtle mis-perception. If you look into the internals of a Treasury bond fund of a short duration, you will see individual Treasury Notes arranged in a ladder fashion from 1 year to 5 years. That is not so different than a laddering of CDs arranged from 1 year to 5 years.

I own some brokered CDs, and I can see when the CD's market yield goes up, my CD's net asset value do go down a bit in the same way as a regular bond does. At this point, someone will say "Wait til the CD matures, then you won't lose any money". However, the situation is the same for the individual Treasury Note; you can't lose money if a Treasury Note matures. In fact the CD ladder's average maturity stays the same if maturing CDs are being replaced, which is similar to how a bond fund operates.

At this point you might realize it really does not make sense if you think a CD ladder as something really safe, while a short term Treasury bond fund is being considered as unsafe.
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Re: CDs & Savings as a substitute for bonds or bond funds

Post by BogleMelon » Sun Jan 14, 2018 10:21 pm

Also don't forget about I bonds
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Re: CDs & Savings as a substitute for bonds or bond funds

Post by Dandy » Mon Jan 15, 2018 10:50 am

Since most investment firms and advisers don't make any money on selling or recommending CDs or Savings accounts and since they can't be traded (except for brokerage CDs) you can understand that people tend to refer to allocations as stocks and bonds. It used to be stocks/bonds/cash.

If your fixed income allocation is to provide stability for your allocation then CDs and Savings accounts fit that goal. I still like the "old" way of thinking about allocations as stocks/bonds/cash. So, rather than have all CDs and Savings I think some bond funds should also be considered. If you are in a high tax bracket you might want some tax free bond fund exposure. You also might want some inflation protection especially if you are near or in retirement. An all Savings/CD fixed income is very safe but may not be the only fixed income choice for everyone.

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Re: CDs & Savings as a substitute for bonds or bond funds

Post by ruralavalon » Mon Jan 15, 2018 10:58 am

pfb3326 wrote:
Sun Jan 14, 2018 9:17 pm
Are CDs and savings accounts acceptable alternatives to bonds or bond funds for the fixed income portion of a portfolio? This would seem reasonable to me at times of rising rates when you have about a ten year horizon or am I missing something? Thanks.
Yes.
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dbr
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Re: CDs & Savings as a substitute for bonds or bond funds

Post by dbr » Mon Jan 15, 2018 11:02 am

Of course. I wonder how much of a question like that comes up because one says "bonds" when one really means all those things.

If you are buying at the US Treasury most of their offerings are not bonds because they are notes and bills unless they are savings bonds, which are not bonds or they are "securities" as in TIPS, which are bonds.

"Fixed Income" by the way, is neither fixed nor income.

It might be a better way to talk about the assets in a portfolio is to distinguish debt instruments from equity instruments or to distinguish "high" risk holdings from "low" risk holdings.

PS On the other hand the idea that CDs and savings accounts have special virtues in a portfolio compared to the wider range of low risk instruments is overblown.

PPS Anyone want to reopen the question "What is cash?"
Last edited by dbr on Mon Jan 15, 2018 11:03 am, edited 1 time in total.

indexonlyplease
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Re: CDs & Savings as a substitute for bonds or bond funds

Post by indexonlyplease » Mon Jan 15, 2018 11:03 am

I keep seeing the words high tax bracket.

Can someone tell me at what % is high tax bracket starts 25,28, 30% ????

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Re: CDs & Savings as a substitute for bonds or bond funds

Post by dbr » Mon Jan 15, 2018 11:06 am

indexonlyplease wrote:
Mon Jan 15, 2018 11:03 am
I keep seeing the words high tax bracket.

Can someone tell me at what % is high tax bracket starts 25,28, 30% ????
For purposes of making choices between tax exempt and taxable bonds it is wherever you personal tax situation shows a benefit to tax exempt holdings. I suppose on average people suggest to start taking the analysis seriously when one is at 25%, but really the business of holding munis is more to the point when considering state taxes. That is why munis come in state specific flavors.

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Re: CDs & Savings as a substitute for bonds or bond funds

Post by indexonlyplease » Mon Jan 15, 2018 11:20 am

got it.

thanks

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Re: CDs & Savings as a substitute for bonds or bond funds

Post by visualguy » Mon Jan 15, 2018 2:37 pm

The problem with CDs is what to do when the stock market goes down significantly, and you want to re-balance into stocks. You may need to break some CDs and pay EWP, or sell brokered CDs for whatever they are worth on the market. Also, there's the problem that with brokered CDs, the interest doesn't get re-invested, and you get these occasional interest payments that you need to invest, so a lot more hassle with this and with maturing CDs that need to be invested as well.

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Re: CDs & Savings as a substitute for bonds or bond funds

Post by Kevin M » Mon Jan 15, 2018 3:20 pm

One thing that can reduce the term risk of CDs purchased directly from a bank or credit union is the early withdrawal option. This limits the downside risk to the amount of the early withdrawal penalty. So a ladder of direct CDs with low early withdrawal penalties is indeed less risky than a similar ladder of Treasuries or a Treasury bond fund with similar duration.

A brokered CD does not have an early withdrawal option, so is essentially has the same term risk as a bond of the same maturity.

So a ladder of brokered CDs has similar risk to a ladder of Treasuries of same maturities. You may get higher yields on CDs of certain maturities, but the liquidity is better for Treasuries, so if you need/want to sell before maturity, it will cost you less with Treasuries.

Currently Vanguard shows the 1-year Treasury at 1.83% and a new-issue 1-year CD at 1.80%. You may get a slightly lower yield for the Treasury unless you buy a large quantity, but still you'll be in the ballpark of the CD, and with better liquidity. So I might favor the Treasury over the CD for the 1-year rung of a ladder.

At two years, I see the CD at 2.25% and the Treasury at 2.02%, so if you're fairly certain you'll hold to maturity, the CD provides 23 basis points of extra yield. You might find a 2-year CD on the secondary market at an even higher yield, but it's harder if you're paying $2 per CD in commission. You pay $1 per CD if you are Flagship Select or higher ($500K or more in Vanguard products), and Fidelity charges $1 per CD/bond for everyone.

I also see direct 2-year CDs in the 2.25% ballpark, and for this short of a term, term risk is not a big concern, so I'd be OK with a 2-year brokered CD rather than having to mess around with another account to get a direct CD with about the same yield.

The CDs beyond two year maturities all have a yield premium over Treasuries of same maturity, but much less so than in recent years. I'd start to look more at direct CDs with low early withdrawal options for terms beyond three years if you're willing to deal with multiple banks and/or credit unions to get the best deals.

Another advantage to holding individual securities is if you are not simply rolling your ladder, but using at least some of the proceeds of maturing CDs or bonds to fund living expenses or other liabilities. With a fund you don't have a choice of which maturities to sell, so you might have a loss or gain when you sell shares to fund expenses. From this perspective, a non-rolling ladder of individual bonds or CDs is less risky.

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Re: CDs & Savings as a substitute for bonds or bond funds

Post by Kevin M » Mon Jan 15, 2018 3:29 pm

visualguy wrote:
Mon Jan 15, 2018 2:37 pm
The problem with CDs is what to do when the stock market goes down significantly, and you want to re-balance into stocks. You may need to break some CDs and pay EWP, or sell brokered CDs for whatever they are worth on the market.
A solution to this is to do some of each. You might hold your expected rebalancing funds in a bond fund. It's also quite possible that you'll have some CDs maturing when it's appropriate to rebalance into stocks (this has happened to me). Also, if you get a high enough premium over Treasuries, you are likely to come out ahead over time even when paying higher bid/ask spreads in selling brokered CDs (vs. Treasuries) or paying the EWP on a direct CD. The CD premiums over Treasuries aren't nearly as high as they have been in recent years--my average premium for CDs bought since late 2010 is about 115 basis points, while the premium on a good 5-year CD now is closer to 30 basis points.
Also, there's the problem that with brokered CDs, the interest doesn't get re-invested, and you get these occasional interest payments that you need to invest, so a lot more hassle with this and with maturing CDs that need to be invested as well.
Yeah, reinvestment of interest is a nice advantage of direct CDs. For brokered CDs or individual bonds, I'd just let the interest blow to a money market account or bond fund, and then perhaps buy another batch of CDs/bonds when I've accumulated enough interest. And good point that there is more work involved in managing your own ladder vs. using a fund. Unless you see clear benefits to managing your own ladder for at part of your fixed income (as I do), then a bond fund probably is a better way to go.

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Re: CDs & Savings as a substitute for bonds or bond funds

Post by oneleaf » Mon Jan 15, 2018 4:35 pm

For the past several years (since shortly after the GFC), CD's and savings accounts have been pretty good alternatives to bond funds. However, nowadays, I am finding Short Term Treasuries and Intermediate Term Treasuries to be only slightly less yield than the best CD's. And in a taxable account in Oregon, about equal (or slightly better) after-tax yield.

Furthermore, when rebalancing OUT of fixed income and into stocks, bond funds are nice. Yes, they can decline, but they can also go up. Whereas breaking a CD early to rebalance out of fixed income and into stocks is always a penalty, so you don't get the benefit of any drop in rates.

I'd say, generally, bond funds are better for easy portfolio management and, in the long run, the declines and the gains even out. CD's can be a good replacement during extended periods (such as after the GFC) where CD's were way higher than equivalent term treasuries.

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Re: CDs & Savings as a substitute for bonds or bond funds

Post by sport » Mon Jan 15, 2018 7:39 pm

Kevin M wrote:
Mon Jan 15, 2018 3:29 pm
Yeah, reinvestment of interest is a nice advantage of direct CDs.
In addition to the automatic reinvestment of interest, some direct CDs automatically roll over to a new CD of the same maturity. This is a bad feature if the new rate is not competitive (perhaps by design) and requires the investor to stay on top of things.

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Re: CDs & Savings as a substitute for bonds or bond funds

Post by radiowave » Mon Jan 15, 2018 7:44 pm

sport wrote:
Mon Jan 15, 2018 7:39 pm
Kevin M wrote:
Mon Jan 15, 2018 3:29 pm
Yeah, reinvestment of interest is a nice advantage of direct CDs.
In addition to the automatic reinvestment of interest, some direct CDs automatically roll over to a new CD of the same maturity. This is a bad feature if the new rate is not competitive (perhaps by design) and requires the investor to stay on top of things.
This is where Ally shines with it's online interface to CDs, you can set what happen at maturity, where the funds go (e.g. into an Ally checking or other account) and how the interest gets distributed. You can do this only the fly anytime you like. Is there any other bank that has this same utility?
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Re: CDs & Savings as a substitute for bonds or bond funds

Post by Kevin M » Mon Jan 15, 2018 8:29 pm

sport wrote:
Mon Jan 15, 2018 7:39 pm
Kevin M wrote:
Mon Jan 15, 2018 3:29 pm
Yeah, reinvestment of interest is a nice advantage of direct CDs.
In addition to the automatic reinvestment of interest, some direct CDs automatically roll over to a new CD of the same maturity. This is a bad feature if the new rate is not competitive (perhaps by design) and requires the investor to stay on top of things.
Yeah, you definitely should not be using direct CDs to optimize your risk-adjusted yield unless you "stay on top of things". I enter my CD maturity dates in my calendar, and usually call a few weeks ahead to instruct them to deposit the proceeds of my maturing CD in savings if the new CD rates are not competitive. Or, for IRA, I might initiate an IRA transfer before the CD matures, with the instruction to transfer the proceeds to the new IRA custodian when the IRA CD matures (just dropped one such IRA transfer form in the mail today).

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Re: CDs & Savings as a substitute for bonds or bond funds

Post by sport » Mon Jan 15, 2018 9:13 pm

Kevin M wrote:
Mon Jan 15, 2018 8:29 pm
sport wrote:
Mon Jan 15, 2018 7:39 pm
Kevin M wrote:
Mon Jan 15, 2018 3:29 pm
Yeah, reinvestment of interest is a nice advantage of direct CDs.
In addition to the automatic reinvestment of interest, some direct CDs automatically roll over to a new CD of the same maturity. This is a bad feature if the new rate is not competitive (perhaps by design) and requires the investor to stay on top of things.
Yeah, you definitely should not be using direct CDs to optimize your risk-adjusted yield unless you "stay on top of things". I enter my CD maturity dates in my calendar, and usually call a few weeks ahead to instruct them to deposit the proceeds of my maturing CD in savings if the new CD rates are not competitive. Or, for IRA, I might initiate an IRA transfer before the CD matures, with the instruction to transfer the proceeds to the new IRA custodian when the IRA CD matures (just dropped one such IRA transfer form in the mail today).

Kevin
The bank I use for direct CDs always has competitive rates. But they are for "special CDs" with odd maturities, such as 17 months, 26 months, or 39 months. When these mature, the specials are for different maturities (of course). Then, instead of getting 2.XX%, they will renew at a rate of 0.40% or something similarly disadvantageous unless action is taken. This is causing me to change to brokered CDs for those I expect not to cash prior to maturity.

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Re: CDs & Savings as a substitute for bonds or bond funds

Post by Dandy » Mon Jan 15, 2018 10:35 pm

reinvestment of brokerage CD interest is not as much of a disadvantage in a rising rate environment especially for shorter terms.

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