Why Invest In Certificates of Deposit (CD) When Rates Are So Low
I love CDs because they let me rest easy. Roughly 30% of my net worth is in CDs and other stable instruments currently yielding a blended rate of around 3.75%. Even with rates so low, if I invest $250,000 at 2.3% I still earn $479 a month, which is a very nice chunk of guaranteed change for an early retiree.
What’s interesting to note is that as of February 4, 2013, the 10-year yield has risen to around 1.95% while a 7-year CD is yielding 2.1%. In other words, there is an arbitrage opportunity here because one can invest in a CD with a higher yield and at a shorter duration period.
It is rare for a CD to yield a higher rate and have a shorter duration than the 10-year Treasury. Whenever this happen, I am an aggressive buyer. 5-year CD yields at Ally Bank are currently at 1.59%, which is also higher than current government yields.
REASONS WHY I INVEST IN CDs DESPITE LOW RATES
* As long as I’m making money, I will have a steady inflow of excess cash given I save over 50% of my after tax income a month. If rates go up, I’m just going to invest in a higher yielding CD for the longest duration possible. It’s not like I’m one and done. The CD ladder is forever growing so long as I have income.
* Accrued interest is accessible. In the event that I no longer have income and no longer have any savings, all the accrued interest earned from my CDs can be withdrawn and used penalty free.
* CDs are 100% backed by the FDIC up to $250,000 per person on the account. I don’t have to worry about some corporate CEO scandal or competitive threats blowing up my specific stock. As a result, I can focus on more productive things.
* CDs offer a much higher interest yield than money markets. People complain about sub 2% CD interest rates when they are in effect 5-10X higher than money market interest rates at 0.2%-0.3%. Money markets are the real travesty! I’ve left the majority of my money in a money market for two months earning 0.3% a year which didn’t feel optimal.
* Diversification is important. Throwing 30% of my recurring savings in CDs is prudent, leaving me with 70% to invest in the stock market, real estate market, or in myself. It was fun buying Facebook for a 30% gain. But I’m under no delusion I will continue to get lucky. I also keep my single stock investments to around $25,000 due to my risk metrics. I’m unwilling to invest in Treasuries because of how high they’ve risen already and their lower rates than CDs.
* Passive guaranteed income is becoming more valuable. Right now I’ve got about $2,800 a month in CD interest income. If I threw the entire $250,000 in an Ally CD, my CD income would rise to ~$3,000 a month. With $3,000 a month in guaranteed income for the next several years, I know I will not be begging on the streets if I fail at entrepreneurship. Having the CD interest income safety net helps give me the confidence to create my own luck.
* I’m not greedy. Everybody says that inflation will eat away at my earnings. True, but my absolute capital is still going up with CDs. I’d rather make 1.59% on a CD than lose 5% in the stock market. Interest rates and inflation are tied together. You don’t have high inflation without high interest rates and vice versa. Once you build your nut to live off, you will do everything you can to perserve it because it took so long to build.
* Focusing on my X Factor. Given I’ve got the energy right now, I’m all about focusing on my X Factor. The X Factor is in all of us. We just have to unleash the beast. Often times, we can’t because we’re worried about school, money, family, etc. By putting my money in CDs, I just don’t worry about the funds at all anymore. I can then focus more of my time on my online work, my upcoming book, and other projects that provide MUCH GREATER returns than everything else!
RATES WILL STAY LOW FOR A WHILE
It’s important to get over the fact that the absolute rates are low and look at things relative to other things. When I was investing in 4.5% CDs, people were laughing at me for being so conservative. Well they sure as hell weren’t laughing after they lost 30-50% of the value in the stock market! And they sure as hell weren’t laughing when they lost their jobs due to the implosion in corporate earnings.
We are in an environment of incredible volatility and risk. I’d much rather make 1.59% on my money than 0.1% in a money market account. Furthermore, I’d much rather make 1.73% on my money than LOSE money in the stock markets. Everything is always relative and rates are low because borrowing costs are also low.
If you are a prodigious saver, are willing to keep your money safe for a set duration of time while earning an interest rate above the current risk free rate 10 Year Treausry, and are concurrently investing in other more aggressive instruments, I recommend diversifying your capital into a 5-year CD account or longer duration. The fact that a 5-year CD is yielding about the same as the 10-year Treasury yield is unheard of.
Putting 30% of my net worth in long duration CDs has been one of the absolute best things I could have done for the past 13 years. $100,000 invested 7 years ago at a 4% compounded rate of return is now worth 32% more. I will continue to invest 30 cents for every single dollar I earn in CDs for as long as I make money. I sleep well every night knowing my money will always be there and is getting the best relative return.
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, when my CDs are expiring, and how my net worth is progressing. I can even keep track of my spending. The best feature is the 401K Fee Analyzer which is saving me $1,000+ a year in portfolio fees. There is no better free tool online that I’ve found today. It takes a minute to sign up.
* High Interest Savings Account: I recommend EverBank with a 1.11% yield given 7-year CD rates are at 2%. A 1.10% savings rate where you can freely access your money without penalty is a no brainer compared to locking your money up for 5-10 years at only 2%. Online banking is the best place to park your cash and it’s very convenient to deposit or withdraw money. Don’t let traditional banks get away with paying you nothing in interest as you fall way behind due to inflation!
Photo: 2013 Porsche 911 Carrera. Not everything low is unattractive.
About the Author: Sam began investing his own money ever since he first opened a Charles Schwab brokerage account online in 1995. Sam loved investing so much that he decided to make a career out of investing by spending the next 13 years after college on Wall Street. During this time, Sam received his MBA from UC Berkeley with a focus on finance and real estate. He also became Series 7 and Series 63 registered. In 2012, Sam was able to retire at the age of 35 largely due to his investments that now generate over six figures a year in passive income. Sam now spends his time playing tennis, spending time with family, and writing online to help others achieve financial freedom.
Post Updated in February, 2013.