The DVD Rental Method to CD Investing: The Only Way To Achieve Max Yield
When we first bought our $1,200 HDTV six years ago, we told ourselves never to go to the movies again until we watched enough DVDs to pay for the purchase. Every time we went to the movies, we’d have to pay on average $20 for tickets. A promise was made that only after we watched 75 DVD rentals ($1,500 bucks in movie tickets saved – $300 for Netflix fee), would we treat ourselves out to the theater. We reached our goal within two years, and in the four years afterwards we’ve only gone to three movies!
We realized that once we went through the initial 6 month waiting period for the latest movies to come out on DVD, all was fresh again. We’re now programmed to watch movies with a 6 month lag, bringing us the same opening night excitement. The annoyance of someone sitting right in front of you in an empty theater and jabbering away is no more! Furthermore, a 52″ screen and six point surround sound system sure helps replicate the big screen experience!
THE DVD RENTAL METHOD OF CD INVESTING
Our programmed way of movie watching translates directly into how we employ our CD investment strategy. With the money we carve out for retirement savings (not emergency fund), we seek the highest yielding CD regardless of duration. Current 5-yr CDs are at 3.5-3.75% for example vs. 1.2% for short term savings and 1 year CDs. Every year we don’t put money in a 5 year CD is 2.3%-2.55% in lost interest.
Some may argue inflation risk. Great we say, because rates certainly aren’t going to ramp instantaneously, but if they do, we’ll just dump our next year’s cash into another 5-yr CD with a higher rate. Let’s say for one year, we earn 4% in a 5-year CD vs. 1% in a short term savings account. With a positive 3% spread, our 2nd year short term savings account yield would have to ramp to 7% on average before the benefit of the first year is negated. At 7%, you should happily throw in another chunk of change. This is a problem of positives, not negatives.
There is a chance that you will need to tap your funds before the very initial 5 year period is done. The worst “penalty” that can happen for a 5-year CD is the forefeiture of 6 months worth of interest. Big deal! Chances are low you will need the money after you’ve built an emergency fund. By locking up your money, you are saving yourself from yourself.
CONCLUSION – LADDER UP AND BE PATIENT
Nobody knows how high inflation, and therefore rates will go. But, what we do know is that long term yields are generally always higher than short term yields. The yield at each duration reflect inflationary expectations. After waiting patiently for 5 years, your entire cash savings portfolio will return the highest yield possible. Meanwhile, every year, a good chunk of money comes due so you will always be liquid.
I’ve got six, five year CD’s yielding 6.5%, 6%, 5%, 4.5%, 4.2%, and most recently 3.75%. The average yield is therefore about 5%, easily surpassing the current savings rate & current 5-yr CD rates of 3.5-3.75%. You are allowed to withdraw the interest portion of your CD as well, thereby lowering the need to withdraw the entire tranche and incur a penalty. By employing the DVD method of CD investing, your cash yield is optimized and you practice good long term savings habits along the way.
BONUS: Inflation Fighting Tips & How To Think About Inflation
1) Take on debt. If inflation is really coming, the solution is to take on as much fixed debt as your balance sheet can handle beforehand. Inflation literally inflates away your debt, given you will be paying back your fixed debt with inflated future dollars. In essence you are shorting treasuries, which will go down if inflation goes up, thereby making you money.
2) Buy hard assets. You may also think about buying as much hard assets as you can afford (property and commodities are good examples but not cars), because by definition your assets will inflate higher with inflation. Your cash, on the other hand will be eroded by inflation, so you must at the very least always seek maximum yield.
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Post is updated as of 4Q2013.