learning_head wrote:Thanks Kevin - very interesting line of thinking. I am not sure how you got 30 basis points there (should not it just be 100 basis points per year since 100 basis points was already calculated as yearly yield difference?).

G-Money explained it correctly, and I did reference Larry Swedroe, who is the one from whom I learned about this rule of thumb. Assuming 20 basis points is Larry's number (which I believe it is), then you'd want at least 60 basis points more in yield to extend maturity by three years, and you are getting much more than that.

I also mentioned that the risk of extending maturity on a CD probably is less than extending it on a bond fund, and G-Money elaborated somewhat on that as well. My thinking is that by extending bond fund duration by three years, you risk losing about 3% more for each percentage point increase in rates, so if rates increase by more than one percentage point, you could lose more than 3%, but your loss on the PenFed 3% CD is limited to 3%. Also, the maturity of the CD is continually declining, so your term risk (in terms of opportunity cost) on this particular CD declines over time, although if you maintain a rolling ladder of CDs this may not be very relevant.

learning_head wrote:BTW, I was wondering what would the rates need to be in 2 years to make it break even. If my math is right, rates in 2 years would need to be around 3.52% to reach the break even point between the two approaches, i.e.:

(1+1.85%)^2*(1+3.52%)^3 =~ (1-0.925%)*(1+3%)^5

Noone knows of course if 3.52% rate is likely to be there in 2 years, esp. on 3-year CD; so maybe it's not that useful, not sure.

G-Money agrees with your estimate, so I won't bother thinking about it; I tend to just set up something in a spreadsheet to do these estimates. Unlike G-Money though, rather than assume constant rates, you might look at various yield curves to estimate future rates. Yield curves are at least partially determined by market expectations of future rates. But what yield curve to look at?

Treasury 2yr, 3 yr, 5 yr, 7 yr: 0.3%, 0.6%, 1.43%, 2.16%

This indicates expectation of 30-40 bp increases per year in the 2-7 year range over the next two years, but of course these rates are much lower than comparable CD rates.

CDs, excluding PenFed, 2yr, 3yr, 4yr, 5yr: 1.2%, 1.5%, 1.7%, 2%

Assuming PenFed is a temporary outlier, this indicates 20-30 bp per year, so say 2.6% on a 5-year in two years.

Will be interesting to see if any other banks or CUs raise their rates much to compete with PenFed.

Kevin