Why Total Bond Market over CDs?

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simplesauce
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Why Total Bond Market over CDs?

Post by simplesauce »

Hi all. I have read many books on the subject. Lately, Larry Swedroe is making the most sense to me. Why not buy IRA CDs instead of investing in Total Bond Market? I would like to hear a case for both sides please.

I also have some TIPS. But at the end of the day, aren’t CDs the safest product, and providing similar returns to bonds?

Thanks.
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Alexa9
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Re: Why Total Bond Market over CDs?

Post by Alexa9 »

If you have a significant bond allocation, I would go half CD's if you want. Bonds are very safe even though they fluctuate a bit. But yeah, if CD's are returning more, it's a good move.

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onourway
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Re: Why Total Bond Market over CDs?

Post by onourway »

There are threads on this very topic at least weekly. I would suggest you search the archives and read the regular arguments for both sides. There is a good case to be made for both sides.

My short take.

CD's tie you in to a fixed return. If rates rise, you must pay a penalty to get out and expend the effort to move to a better CD.
CD's are not marked to market which gives people the false impression that they have not lost any money if they stay put in the above situation.
CD's make it difficult to re-balance your account.
CD's must be managed.
Bond funds automatically reap the benefit of increasing rates.
Bond funds make for simple re-balancing.
Bond funds require no management on your part.
Over the long term, other than a few people who regularly chase the best CD rates, bonds will often out-perform CD's.

For most people, over the long run, the majority of their returns will come from the equity portion of their portfolio. As such, the tiny differences between holding bonds and CD's will not amount to anything of significance.
Prudence
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Re: Why Total Bond Market over CDs?

Post by Prudence »

I have been juggling multiple CDs for several years now and I am tired of it and the constraints on liquidity. Also, interest rates are on the rise. So, I am thinking about investing cash I might need within the next two years in my online savings account and a short term Treasury fund and the remainder of my fixed allocation in intermediate Treasuries or total bond fund. Money invested in total bond for five years or more should do better than CDs, but, who knows.
wolf359
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Re: Why Total Bond Market over CDs?

Post by wolf359 »

I buy Total Bond Market for convenience, and because it's a long-term holding. The fewer decisions I have to make, the better.

That said, I consider that FDIC-insured CDs are equivalent in risk to Treasuries. Both are backed by the federal government. I would have no hesitation with buying CDs versus Treasuries.

Total Bond Market is 65% US government securities. About 26% is corporate A or Baa, which are higher risk and higher return. During a downturn, BND will hold its value sufficiently.

If your goal is to rebalance when the market drops, BND is more liquid. You'd have to break a CD to access it, which affects return.

The liquidity of BND means it is marked to market daily. You can always see its value, which means you will see its price fluctuate as interest rates go up and down. That distracts some people, who think they've just lost money even if they had no intention of selling for years. If you hold BND for 20 years, you should get the same value as holding a rolling bond ladder over the same period of time.

I would have no problem with holding both BND and CDs for the best of both worlds. Hold CDs to give the illusion of stability, and hold enough Total Bond Market to allow easy rebalancing.

Sometimes CDs have better returns. Sometimes Treasuries have a better return. Mix and match to take advantage of the better rates.
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jeffyscott
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Re: Why Total Bond Market over CDs?

Post by jeffyscott »

wolf359 wrote: Mon Jan 07, 2019 9:06 amThat said, I consider that FDIC-insured CDs are equivalent in risk to Treasuries. Both are backed by the federal government. I would have no hesitation with buying CDs versus Treasuries.

Total Bond Market is 65% US government securities. About 26% is corporate A or Baa, which are higher risk and higher return. During a downturn, BND will hold its value sufficiently.
In my IRA, I am aiming to mix brokered CDs and (primarily) corp bond funds, rather than use the all-in-one bond index.

CDs have higher yields than treasuries and there is no tax advantage to treasuries in an IRA. I have 3-5 years CD yielding about 3-3.4%, at the time of purchase the spread over equivalent treasuries has ranged from 0.2% to 0.95%. Then I get the corp bond component via mutual funds.

I have only been at this for about 6 months or so, following a rollover which opened up the opportunity to use CDs, but I think CDs plus, for example, Vanguard intermediate investment grade (VFIDX) > Bond index fund.
If your goal is to rebalance when the market drops, BND is more liquid. You'd have to break a CD to access it, which affects return.
I will not sell my brokered CDs in order to rebalance. I'm not sure what one might expect as a potential rebalancing bonus, but I think I would rather take the certainty of a yield premium, averaging about 0.5% so far for me, rather than hope for a rebalancing bonus.
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InvestInLife
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Re: Why Total Bond Market over CDs?

Post by InvestInLife »

If interest rates are substantially equal between the two, the reason I hold bonds is that mine are muni bonds and therefore tax-free. CD interest income would be taxable at my normal rate, which can approach 50% some years. If it weren’t for that, I would probably hold more in CDs that will be held to maturity for stability, as they won’t fluctuate in value like a bond fund does. I do keep 10k in CDs as an emergency fund. The few minutes of work to manage a CD ladder ... I never noticed, but I keep them at quarterly maturities so I only do it four times per year.
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Re: Why Total Bond Market over CDs?

Post by danielc »

simplesauce wrote: Mon Jan 07, 2019 8:41 am Hi all. I have read many books on the subject. Lately, Larry Swedroe is making the most sense to me. Why not buy IRA CDs instead of investing in Total Bond Market? I would like to hear a case for both sides please.

I also have some TIPS. But at the end of the day, aren’t CDs the safest product, and providing similar returns to bonds?
Here's how I see it:

In my view, CDs are a type of bond. Most CDs you get at your bank give you the right but not the obligation to sell the CD back to the bank early at a predictable price. In general you can expect to pay some premium for this feature, so the returns of CDs tend to be a little bit lower, and in exchange the prices don't fluctuate when the interest rates change. It is perfectly reasonable to look at both bonds and CDs and just pick whatever seems like the best deal for you at the time. For example, I said that CDs usually return less, but right now longer term CDs from capital one have a higher return rate than US Treasuries. Look:

Code: Select all

Maturity      CapitalOne CD      US Treasury
6 Months      0.60%              2.49%
9 Months      0.75%              2.55%
12 Months     2.70%              2.59%
24 Months     2.80%              2.53%
30 Months     2.80%              2.49%
60 Months     3.10%              2.51%
So right now, if I wanted a maturity less than a year I would pick a treasury, but if I wanted a year or longer I would pick the CD.
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Re: Why Total Bond Market over CDs?

Post by Sandtrap »

simplesauce wrote: Mon Jan 07, 2019 8:41 am Hi all. I have read many books on the subject. Lately, Larry Swedroe is making the most sense to me. Why not buy IRA CDs instead of investing in Total Bond Market? I would like to hear a case for both sides please.

I also have some TIPS. But at the end of the day, aren’t CDs the safest product, and providing similar returns to bonds?

Thanks.
It's neither a "one size fits all" or "all or nothing" scenario.

Prudence would say, "why not diversify the fixed side of your portfolio to include any combination of; High yield accounts, Money Market, CD Ladders, Treasuries, or TIPS, Muni's, Total Bond Index, etc.??"
Last edited by Sandtrap on Mon Jan 07, 2019 12:06 pm, edited 1 time in total.
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retiredjg
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Re: Why Total Bond Market over CDs?

Post by retiredjg »

One reason to prefer bond mutual funds, especially TBM, is that CDs are not available in work plans like a 401k account. Good bond funds frequently are available.

A work plan is the perfect place to hold bonds. Many people have work plans. A traditional IRA is also a perfect place to hold bonds or CDs if you can get them. I believe fewer people have traditional IRAs and the number is getting smaller since Roth iRAs have become available.

Whether one holds bond funds or CDs is personal preference in my opinion.
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Post by 2015 »

Sandtrap wrote: Mon Jan 07, 2019 12:05 pm
simplesauce wrote: Mon Jan 07, 2019 8:41 am Hi all. I have read many books on the subject. Lately, Larry Swedroe is making the most sense to me. Why not buy IRA CDs instead of investing in Total Bond Market? I would like to hear a case for both sides please.

I also have some TIPS. But at the end of the day, aren’t CDs the safest product, and providing similar returns to bonds?

Thanks.
It's neither a "one size fits all" or "all or nothing" scenario.

Prudence would say, "why not diversify the fixed side of your portfolio to include any combination of; High yield accounts, Money Market, CD Ladders, Treasuries, or TIPS, Muni's, Total Bond Index, etc.??"
Indeed, prudence might say that. But simplicity (and laziness!) might argue against it. While I have one CD, a HY account a MM account and total bond, that's as far as I'm going in reaching for yield. The idea of the never ending search for and juggling of CD's, worrying about early retirement penalties, rising interests rates, etc. is unattractive to me.
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Re: Why Total Bond Market over CDs?

Post by bhsince87 »

An advantage of bond funds is the ability to tax loss harvest. I did that last year.

That being said, I use both CDs and bond funds. And MMF as well. I lump them all into my "fixed income" basket.
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Earl Lemongrab
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Re: Why Total Bond Market over CDs?

Post by Earl Lemongrab »

retiredjg wrote: Mon Jan 07, 2019 12:06 pm One reason to prefer bond mutual funds, especially TBM, is that CDs are not available in work plans like a 401k account. Good bond funds frequently are available.
This is a big part of it. I have about 800k allocated to fixed income these days. Up until 2018, it was all in the 401(k) by necessity. I wasn't going to use my Roth IRA space for that. So I had 50/50 bond index and stable value.

Now, theoretically I could roll out the fixed income, or at least the bond part. But do I really want to fool around managing 400k worth of CDs? No I do not. Even if there were a possible rate advantage, likely my management would more than wipe that out because CDs would mature and roll into not-so-good ones.

The bond index fund is super easy and simple. Why would I want to chase a tiny bit of yield?
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jeffyscott
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Re: Why Total Bond Market over CDs?

Post by jeffyscott »

Earl Lemongrab wrote: Mon Jan 07, 2019 2:22 pm
retiredjg wrote: Mon Jan 07, 2019 12:06 pm One reason to prefer bond mutual funds, especially TBM, is that CDs are not available in work plans like a 401k account. Good bond funds frequently are available.
This is a big part of it. I have about 800k allocated to fixed income these days. Up until 2018, it was all in the 401(k) by necessity. I wasn't going to use my Roth IRA space for that. So I had 50/50 bond index and stable value.
Just about the same situation here, but I have rolled over, in part, because I did not like the bond index fund or stable value. I'd not planned to do CDs until Kevin here introduced me to the concept of brokered CDs last summer.

I may end up allocating around 10% to CDs, that'll be around 1/6th of fixed income. So using your $800K figure, that'd be ~$133K, with maybe 10K in each of 13 CDs or something like that. If they are spread out over 5 years, that's just 2-3 that I would buy each year, after the initial flurry. I am only going to use brokered CDs, not going to be chasing direct CD deals.

I won't set up any automatic rollovers, as I kinda like looking for the deals in secondary brokered CDs, anyway. My spouse would never want to do this, though, so I recognize that it is not for everyone.
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Re: Why Total Bond Market over CDs?

Post by Scooter57 »

onourway wrote: Mon Jan 07, 2019 8:50 am There are threads on this very topic at least weekly. I would suggest you search the archives and read the regular arguments for both sides. There is a good case to be made for both sides.

My short take.

Bond funds automatically reap the benefit of increasing rates.
No. They don't. The NAV of the bond fund drops when rates rise and contrary to what many people seem to think, the interest payments don't rise to match that NAV drop.


When the yield of the bond fund goes up in response to rising rates people who buy into the fund on that day get the stated interest rate, but the actual interest payment is going to be pretty much what it was the months before. It doesn't rise until bonds age out of the fund and new bonds are acquired.

How soon this happens has to do with the duration of the holdings of the fund.

Don't look at the SEC rate of a bond fund to see how it is doing, look at the total return for the previous year. As you can see, with last year's rate rises most bond funds have a negative total return for the year.

With a CD ladder, you buy CDs of various terms, ie. 6 mo, 1 yr, 2, yr, etc up to 5 yr, so you should always have some money coming due each year as that year's CDs mature, which keep you from having to pay an early withdrawal penalty.
onourway
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Re: Why Total Bond Market over CDs?

Post by onourway »

Scooter57 wrote: Mon Jan 07, 2019 3:00 pm
onourway wrote: Mon Jan 07, 2019 8:50 am There are threads on this very topic at least weekly. I would suggest you search the archives and read the regular arguments for both sides. There is a good case to be made for both sides.

My short take.

Bond funds automatically reap the benefit of increasing rates.
No. They don't. The NAV of the bond fund drops when rates rise and contrary to what many people seem to think, the interest payments don't rise to match that NAV drop.


When the yield of the bond fund goes up in response to rising rates people who buy into the fund on that day get the stated interest rate, but the actual interest payment is going to be pretty much what it was the months before. It doesn't rise until bonds age out of the fund and new bonds are acquired.

How soon this happens has to do with the duration of the holdings of the fund.

Don't look at the SEC rate of a bond fund to see how it is doing, look at the total return for the previous year. As you can see, with last year's rate rises most bond funds have a negative total return for the year.

With a CD ladder, you buy CDs of various terms, ie. 6 mo, 1 yr, 2, yr, etc up to 5 yr, so you should always have some money coming due each year as that year's CDs mature, which keep you from having to pay an early withdrawal penalty.
Nothing you wrote here contradicts my statement.
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Re: Why Total Bond Market over CDs?

Post by SpaceCowboy »

I’m a big fan of direct purchased CDs. Think the decision is easy. When the CD yield is higher than the SEC yield of Total Bond, CDs are favored as investments. They also give you the flexibility to trade up to a higher rate CD at a known cost, and thus its easily calculable whether or not to do the trade. The lack of mark to market pricing on CDs is a red herring, as there is a fixed early withdrawal penalty on direct purchased CDs.
When comparing to Treasuries, you need to adjust for the effect of state taxes. Right now I think short term TIPS and CD promotions are the best 0-5 year fixed income investment.
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Re: Why Total Bond Market over CDs?

Post by FrugalInvestor »

wolf359 wrote: Mon Jan 07, 2019 9:06 am I buy Total Bond Market for convenience, and because it's a long-term holding. The fewer decisions I have to make, the better.
This is it in a nutshell for me.
Have a plan, stay the course and simplify. Then ignore the noise!
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Re: Why Total Bond Market over CDs?

Post by jeffyscott »

onourway wrote: Mon Jan 07, 2019 3:10 pm
Scooter57 wrote: Mon Jan 07, 2019 3:00 pm
onourway wrote: Mon Jan 07, 2019 8:50 am There are threads on this very topic at least weekly. I would suggest you search the archives and read the regular arguments for both sides. There is a good case to be made for both sides.

My short take.

Bond funds automatically reap the benefit of increasing rates.
No. They don't.
Nothing you wrote here contradicts my statement.
Stating that "Bond funds automatically reap the benefit of increasing rates". Implies that bond funds benefit in some way when interest rate increase. Of course, they don't, an increase causes a loss.

I assume you mean that you see some benefit to the fund as buys higher yielding bonds over time, after the increase. But this is no different than what would happen with a ladder of CDs, you would buy new, higher yielding ones, as the old ones mature. Basically you are (I think) just saying the bond fund automatically reinvests as bonds mature (or are sold), but that is already covered by another of your statements: "Bond funds require no management on your part".
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munemaker
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Re: Why Total Bond Market over CDs?

Post by munemaker »

onourway wrote: Mon Jan 07, 2019 8:50 am
CD's are not marked to market which gives people the false impression that they have not lost any money if they stay put in the above situation.
Comment: CDs bought through a broker such as Vanguard or Fidelity are marked to market daily. CDs purchased directly from a bank are not.
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Re: Why Total Bond Market over CDs?

Post by Scooter57 »

There is no need to mark to market a CD bought directly as you know exactly what the early withdrawal penalty is and can easily find out what the rate would be if you broke it early.
https://www.depositaccounts.com/tools/e ... lator.aspx

There is also a helpful calculator that tells you if you will come out ahead breaking a CD and reinvesting it if the rates rise.

https://www.depositaccounts.com/tools/b ... lator.aspx

The biggest difference between the direct CD and a bond fund is that you know in advance what you will end up with at any point in the entire period of the CDs length. There is no such clarity with the bond fund.
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Re: Why Total Bond Market over CDs?

Post by Horton »

I don't like the hassle of opening new accounts and moving money around each time CD's mature. That said, I acknowledge that there are times - e.g., a few years ago - where the expected returns on CD's exceeded Treasury/TIPS funds under every conceivable scenario, so it was worth the hassle.
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Re: Why Total Bond Market over CDs?

Post by Austintatious »

Scooter57 wrote: Mon Jan 07, 2019 6:05 pm There is no need to mark to market a CD bought directly as you know exactly what the early withdrawal penalty is and can easily find out what the rate would be if you broke it early.
https://www.depositaccounts.com/tools/e ... lator.aspx

There is also a helpful calculator that tells you if you will come out ahead breaking a CD and reinvesting it if the rates rise.

https://www.depositaccounts.com/tools/b ... lator.aspx

The biggest difference between the direct CD and a bond fund is that you know in advance what you will end up with at any point in the entire period of the CDs length. There is no such clarity with the bond fund.
OP, that last paragraph of Scooter57's which I've emboldened is, in my opinion, the most important distinction in considering which of the two types of assets is the safest. With CDs, one know his/her principal will remain intact and that at least the cumulative earnings will always be increasing at the prescribed rate over the term of the CD. If that's what one means when speaking of safety, then CDs are the clear choice. They offer a degree of predictability that TBM does not, though that certainly does not mean CDs are necessarily going to earn the investor greater returns over a given period of time.
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Re: Why Total Bond Market over CDs?

Post by scamper »

CD's are as safe as Treasury for the small guy due to FDIC insurance.

I watch depositaccounts.com and Fidelity's fixed income page with the "highest yields" setting (https://fixedincome.fidelity.com/ftgw/fi/FILanding). Keep track of the CD's, TIPS, i-bonds, and ee-bonds on a spreadsheet; benchmarking the investments to the current CD & Treasury yield curve. I am matching the yield of bond funds that include corporate bonds with similar duration, ie. less risk for same return. In the past year, I've snagged some good yields - two 5 year 4% CD's at credit unions; the current MACU.com 3.4% 5 year "add as you go" function. I'm lucky to have a workplace 401k with the "brokerage link" option - allowing me to invest in any funds, stocks, CD's, or bonds I wish to - it's a bit harder to find above market brokered CD's, but there is usually a fair amount of spread between the various banks. I count these CD's towards my bond allocation.

Finally, I greatly prefer the ability to manage my own maturities. As rates move, it's my choice whether to exit prior to maturity.
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Re: Why Total Bond Market over CDs?

Post by Day9 »

CDs, Total Bond, Intermediate Investment Grade, Intermediate Treasury, TIPS, I-bonds -- all fine choices. I understand OP wants to hear the arguments either way but I just want to say all of these are good choices for the bond allocation of a stock & bond retirement portfolio and even if they pick an unoptimal choice among these it will still be a good one.
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