Current CD vs. bond yields

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Post Reply
codemonkey
Posts: 2
Joined: Tue Oct 23, 2018 12:19 am

Current CD vs. bond yields

Post by codemonkey » Tue Oct 23, 2018 12:31 am

I hope this is not a stupid question but why do 2-year CDs currently have an APY of around 3% whereas 1-3 year treasury bond ETFs like SHY (average duration 1.9 years) have only a YTM of around 2.3%.

What am I missing here? Shouldn't bonds have about the same rate as CDs?

Valuethinker
Posts: 36342
Joined: Fri May 11, 2007 11:07 am

Re: Current CD vs. bond yields

Post by Valuethinker » Tue Oct 23, 2018 7:54 am

codemonkey wrote:
Tue Oct 23, 2018 12:31 am
I hope this is not a stupid question but why do 2-year CDs currently have an APY of around 3% whereas 1-3 year treasury bond ETFs like SHY (average duration 1.9 years) have only a YTM of around 2.3%.

What am I missing here? Shouldn't bonds have about the same rate as CDs?
Small investors can choose between either.

If you have $100m or $1 bn to invest, you can't. That kind of money is higher risk if it is not invested with the US Federal government.

Thus from the point of view of an individual investor, US Treasury bonds are overpriced, ie too low a yield, relative to CDs.

A related point is that banks desire liquidity from "sticky" deposits that small retail investors provide via CDs. You are relatively unlikely to cash it in early, so from the bank's point of view it is more secure funds.

User avatar
vineviz
Posts: 2047
Joined: Tue May 15, 2018 1:55 pm

Re: Current CD vs. bond yields

Post by vineviz » Tue Oct 23, 2018 8:08 am

Valuethinker wrote:
Tue Oct 23, 2018 7:54 am
Small investors can choose between either.

If you have $100m or $1 bn to invest, you can't. That kind of money is higher risk if it is not invested with the US Federal government.
In addition to this constraint on market efficiency, I'd point out three things.

One is that CD interest is generally fully taxable to investors whereas treasury interest payments are exempt from state and local taxes (which average about 7.4% in the US), so the after-tax difference is somewhat smaller.

Second is that CD rates are not marked to market (they are just a bank account, after all) so constant maturity treasury bond funds can - and usually do - return more than their initial YTM over time.

Third is that while the best 2-year CD rates are near 2.8%, the average 2-year CD rate in the U.S. is just 0.94%.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

codemonkey
Posts: 2
Joined: Tue Oct 23, 2018 12:19 am

Re: Current CD vs. bond yields

Post by codemonkey » Tue Oct 23, 2018 9:21 am

Thanks for confirming that there is in fact a difference and I wasn't just looking at the wrong numbers.

Is there anything comparable to CD rates that you can by via a broker? I don't want to open yet another bank account.

What about brokered CDs or floating rate treasury funds, for example? Or do you get a better yield if you buy treasury bonds directly instead via an ETF (aside from the expense ratio)?

Is there anything in the fixed income segment that was going up in market correction of last week (not talking about shorting)? Traditionally, long term bonds could be used for hedging but given the raising interest rates, it's probably not a good idea to buy those. Note, I am not talking about sophisticated hedging strategies, just whether the classic stock+bonds combination still makes sense.

Post Reply