Should I Invest In CDs And Other Questions To Ask Before You Do
For my cash asset class, I pretty much dump all my money into long term CDs. My net worth is divided almost equally into stocks, bonds, cash, and real estate. I didn’t plan for it to be this way, it just happened and I don’t mind one bit. I love real estate the most because I like having a real asset which is tangible, produces income, and provides a hedge against inflation. My second favorite asset class is cash.
Cash is the only true means of passive income generation. I literally don’t have to do anything for the interest income earned after I decide on a CD. It just compounds and automatically renews to another similar duration CD after the initial period is over. My goal is to generate five figures a month in interest income from my CDs by the time I retire.
QUESTIONS TO ASK BEFORE INVESTING IN A CD
CDs are like bonds that do have a principal value. You just don’t see the day to day movements, which makes them seem like they are safer investments than fixed income. The truth of the matter is, they have risk but it’s not much if you do the right things. Ask these questions first:
* Is the bank FDIC insured? If so, you can sleep sound at night knowing that $250,000 per single account is guaranteed by the government.
* Are there any upcoming purchases you will have during the duration of the loan?
* What are the penalties for early withdrawal?
* Do you have enough liquid cash in reserves (emergency fund as some call it) to keep me liquid and feeling comfortable?
* Do you have a propensity to spend idle cash in your bank on things which don’t help you build wealth eg cars, clothes, shoes, jewelery, and other material things.
* Do you plan to stay at your current job for the foreseeable future, thereby allowing you to keep saving money every month?
* What is your risk appetite for stocks, bonds, and other asset classes?
* Do you have a comfortable asset allocation in place where your principal will be protected during downturns, and you’ll be able to make money during upturns?
* Are there other asset classes that are more tax advantageous with similar risk and returns?
* Do you believe that the inflationary environment will be relatively benign in the next year or two?
SAVE AND SAVE SOME MORE
Ask yourselves all of the above questions and realize that saving money in CDs is never a bad thing. It might be the suboptimal investment, but it is not bad. You can literally calculate how much cash you have after a certain amount of years, which provides a lot of comfort for many people. What’s bad is letting your money sit in a <1% savings account and spending the money on something stupid like a car.
I’ve often done sub-optimal things with the money that just sits in my bank account. I’ve bought luxury automobiles, motorcycles, multiple suits and expensive rare watches. I’ve made loose $200-$500 poker calls because of a large bank roll. I’ve invested in an iffy private company, which may or may not provide a solid return. I’ve also done plenty of dumb ass things as well which have lost me a ton of money. In other words, sometimes I need to protect myself from myself!
Every year you keep your cash in a savings account is another year you lose out on a higher interest return. If you plan to save and work for a while, you don’t have to be afraid of not being liquid enough because you will always have money coming in. The main thing is to not stop saving. It’s what sets you free.
Recommended Actions For Increasing Your Wealth
* Manage Your Finances In One Place: Get a handle on your finances by signing up with Personal Capital. They are a free online platform which aggregates all your financial accounts in one place so you can see where you can optimize. Before Personal Capital, I had to log into eight different systems to track 28 different accounts (brokerage, multiple banks, 401K, etc) to manage my finances. Now, I can just log into Personal Capital to see how my stock accounts are doing and when my CDs are expiring. I can also see how much I’m spending every month. If you are interested, they can even provide tailored financial advice for much cheaper than traditional wealth managers. Personal Capital takes less than one minute to sign up!
* Invest in short-term CDs. I recommend investing in an Ally Bank CD. They were voted the #1 online bank by Money Magazine in 2012 and have some of the highest rates because they do not have high overhead costs like the traditional bricks and mortars banks. As of Feb 4, 2013 Ally Bank is offering a 0.94% 12-month CD to park your money, or a 5-year CD at 1.59%. To sign up, click here.