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. Their best feature is their “401(k) and Portfolio Fee Analyzer” which showed I’m paying $1,700 a year in portfolio fees I had no idea I was paying! Personal Capital takes less than one minute to sign up and is free.

* Open A Yield Pledge Account: Check out the latest offerings from EverBank and take advantage of their account offerings and Yield Pledge Promise. EverBank offers competitive CD, Money Market, and Checking interest rates. You may even qualify for a bonus rate on their checking and money market accounts, which are just as good as a CD with less tie up. Park your money with online banks with higher interest rates while you wait for better investment opportunities.

Updated: 7/11/2014

Regards,

Sam

Sam started Financial Samurai in 2009 during the depths of the financial crisis as a way to make sense of chaos. After 13 years working on Wall Street, Sam decided to retire in 2012 to utilize everything he learned in business school to focus on online entrepreneurship.

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Comments

  1. says

    For our last car, I had the cash, but I bought it at 0.9% interest from the dealer and put the equivalent in a 4.5% CD at the same time. So, I basically snagged a 3 year free 3.6%. I love putting money to work. At the same time, the market crashed, rallied and I probably would be flat about now if I’d invested it. So, I had a risk-free 3.6% (if you exclude the depreciation on the car of course)

    • says

      You made a good move, if a car was something you had to buy anyway.

      If one made 4% a year in their “sleepy CDs” for the past 11 years, they’d have 60%+ more money than when they started, with ZERO stress vs stocks.

      Hence, why viewing CASH as an important asset class is important.

    • says

      Arbitrage! I dig it.

      I’m thinking about doing this with some *eeek* student loan money in the coming years. With so many members of my family soon to be full-time students, I might be able to access subsidized loans at 3.4% for 10 years. If that is the case, and I can get $5500 at 3.4% for 10 years, I’ll be darned if I’m not going to borrow it just for the purposes of having the liquidity. I imagine I’ll be able to get a risk-free rate higher than that with ease in the coming years.

  2. says

    Excellent points Sam! CDs have a role in one’s portfolio. In 2000, CD rates peaked at over 7%. Imagine if one had locked into some long term CDs at that time!

    Even better strategy is of course to ladder the CDs.

  3. says

    I do not currently own any CDs, but I have at different times. Your plan is quite thought provoking though. Having a five figure income from CDs would be a great thing! I also like how Darwin took advantage of the interest rate on his car and invested the cash.

    • says

      No interest in maximizing the cash portion of your net worth?

      Yes, $10,000 in interest income/month from CDs is the goal, and if I can get $10,000 in income from the other three investment buckets as well, retirement should be pretty easy! Fun goal to have.

      • says

        I definitely would like to optimize my cash. However, the lack of liquidity has always been a major down side to CDs for us.

        I am also guessing you have more cash lying around than we do in that you can ladder your CDs and still have a sizable ‘emergency fund’ sitting in cash that is accessible. A lot of our ‘extra’ money goes into college funds and such, so our cash position is probably not what it should be.

        • says

          College decisions are much more complex than when I was a kid! We have been visiting a lot of colleges already. I have a child graduating in 2012, 2014 and 2016, so I still have a lot more visiting to go!

  4. says

    I agree there is a need for a cash portion and CDs are one way to invest. With inflation expected, I would ladder the CDs, so I could take advantage of the increasing interest rates. That is break up the cash into a number of CDs with different maturity dates.

  5. Arthur Garcia says

    Interesting post, the only problem I have with investing in CDs, especially right now is that inflation wipes out any real return. I really think you’re better locking in a fix rate mortgage and SLOWLY paying down the debt with the tenants rent money. If you think about it, real estate offers the only truly offensive strategy, you have a real asset, a locked in interest rate (which is tax-deductable) and with depreciation, you don’t have to pay capital gains on your return. Do you agree?

    • says

      I agree, and that’s all fine and dandy, but we are strictly talkig about the optimization of cash. In another post, we can talk about the optimization of real estate and debt as an inflation hedge.

      Do you think when people were losing 50% of their equity in stocks they cared about real returns?

  6. says

    Who else remembers the days of 4% accounts at just about every neighborhood bank and credit union? Those were the days.

    I would second the points made about inflation creating negative real returns, but then again, what else can you do with your cash these days?

    I respectfully disagree with the slow pay down on any debt, such as a mortgage.

    Free cash flow is always King in any investing environment and the quickest way to get there is to eliminate any permanent drain on incoming funds.

    At least, that’s how I look at it.

    I’m also pathologically opposed to debt though.

    • Arthur Garcia says

      Macro,

      I appreciate your point of view, even though it is not one I subscribe to. Debt is definately a two edge sword and if someone is uncomfortable with managing it, It makes sense to minimize your exposure (seriously not knocking your point of view).

      The nice thing is that you have options with the freed up cash flow to either pay down the mortgage quicker (with the tenant’s money), reinvest for bigger gains or subsidize your lifestyle .

      If you’re making 20% ROI on your downpayment, then consider a mortgage at 6% is really 5%-4% with interest deductions. To top it off the cash flow is usually sheltered by the depreciation, so you don’t have to pay the taxes on the gains.

      Anyway you cutt it, real estate is the best place to put money right now. The dollar’s value is dropping through the floor and I am sure we’ll see QE3 come fall, so I really think paying back debt with cheaper dollars is a non-convential way of maintaining one’s wealth.

  7. says

    Sam,

    Completely disagree at today’s current rates – Why bother with CDs? Taking a look at ING’s rates today:
    Savings Account .75% / 5 Year CD 1.25%

    Why would anyone lock up their money for .5% pre tax? Even if you had $250K in cash equivalents you are talking about the difference of ~$1500….why lock up the money for an extra $125 a month? You spend that filling up the monster truck in Cali

    • says

      I just plopped some in a 3% CD. 1.25%? Forget about it.

      Are you confusing this post with something else? We are focused on maximizing the cash portion of one’s portfolio/net worth only. I have property, stocks, bonds, and private investments too, which we can talk about in another post.

      • says

        Do I seem confused lol? I am not confused at all – I gave ING’s rate.

        Looks like bank rate has some higher options, but the point is still the same. At $100K of cash the difference between an online savings account and your CD is 2K before taxes or since you are in Cali, you are looking at what a net of $1300 bucks more (or little bit more than 100 bucks a month)? to lock up your money? Just doesn’t seem to make sense.

        Is my math off? 3% vs 1% on a 100K cash account.

  8. says

    I have a hard time justifying CD’s. People are almost too concerned with “safe” investments now, they are letting inflation destroy what they work hard for. Don’t you think that dividend paying stocks (not REITs, but more trusted companies) would be more beneficial? They are many great mutual funds out there for diversification. I get the “cash is king” thinking, but paper money is only as strong as the government backing it… I mean do we honestly think we will have a stock meltdown that will never recover…just seems like a doomsday approach to handling your money.

    • says

      We are talking about the maximization of cash returns. Are you saving you have zero cash in your networth? We can talk about the different investment bucks in a different post. I’m very concerned for you if you have no cash.

  9. says

    Great post Sam! I agree, if you’ve already got a portfolio of stocks, and real estate and you are looking to park some cash and you need to protect yourself from yourself then go with a CD. I just wish the rates were higher…don’t we all, 3% just doesn’t cut it then again you gotta take what you can get.

  10. says

    Sam,
    I understand your point about cash and would probably agree with you on the CDs although depending on my time horizon, I might do something different with it but then it wouldn’t be cash now would it. Really by definition then, there is no legitimate alternative.

  11. says

    I’m not a big fan of CDs, especially at today’s rates, but they do account for a small portion of my investment mix. For those that are curious, here’s what I’m currently doing with them:

    - I have 5 CDs total, each invested for a 5 yr term
    - The CDs are laddered, so 1 resets each year
    - When the CD is set to reset, I spend about 10 minutes on Bankrate and find the best performing 5 yr CD and roll into it.
    - During this roll-over, I add an additional $2k to the CD. This amount isn’t completely arbitrary – my cash savings “emergency fund” kicks out roughly $2k a year in interest, so I’m just reinvesting the interest into a better performing account.

    It’s low effort (10 to 30 minutes a year) … low risk … and, based on my time horizon and cautious assumptions, should more than cover the college tuition of a child if and when that time comes for me.

  12. says

    I don’t have any money in CD since the rate is so so low right now. If the rate goes up a bit then I would think about it more. I only target 15k in cash though so it’s not that much to be sitting around in a saving account. I put anything over that into the investment account. I guess I’m cash poor.

    • says

      If it’s just 15K, then yeah… no point locking it up in a multi-year CD. But, if you’ve got 150K, then letting it all sit in 0.2% money markets is a waste. I’d put $130K in a long term CD at 2.5-3%, and have the rest liquid, especially if you plan to accumulate another 150K the very next year!

  13. says

    CDs have an incredibly low rate right now. I would suggest finding a high-yield checking account to stash some cash. My wife and I currently have quite a chunk of money that’s earning 4% in our checking account. They are out there, take a look.

    • says

      I’ve noticed that a lot of high yield checking accounts only have a LIMIT of how much you can put in, like $5,000 or $10,000. It’s to draw you in. Do you have a limit on your high yield checking? If not, can you let me know which it is? thx

  14. says

    CDs make sense for cash, and nothing else, which seems to be the point of this post. If you’re going to hold cash, then why would you hold it at .01% in a savings/checking account when CDs pay 2-4%, depending on maturity dates, size of deposit, and other things.

    When rates start rising, individual cash holders would be wise also to consider savings bonds. Savings bonds allow you to lock in the present rate, much like CDs, but CD bonds have an interest-yielding term of 20 years plus 10 years after maturity.

    The ability to go longer dated for higher yields should be attractive to most everyone, and savings bonds held for a period of greater than 5 years are not penalized on redemption. If you had bought savings bonds in 2006, for example, you would have locked in a return of 3.6% per year for 20 years! Of course, at that time CDs were paying 5% per year for five years, but the ability to lock in high and long is pretty attractive. After 5 years, a savings bond is as liquid as a 1-year CD, and you’d be hard pressed to find a CD that yields 3.6% for one year right now, but your 20 year savings bond would still yield 3.6%. Minor consolation: savings bonds don’t cash flow.

    At any rate, I’m picking up what you’re putting down: have cash? Get the best return in the easiest way: CDs.

    • says

      Thanks for understanding JT. Cash is a beautiful asset class to manage and optimize. Look beyond cash as just for emergencies, and develop a way for it to be a source of very dependable, low risk income.

  15. says

    I have a few CDs and like the fact that I don’t have to worry about them. Interest rates have dropped a lot though so I haven’t opened any in the last year but I haven’t invested in the stock market in my PA either. I am exposed to the markets with my retirement account though and hold a decent amount of fixed income. I got burned so many times trying to pick my own stocks in my PA so now I just leave it to the pros in my 401k.

  16. Misti says

    Hi,

    Im thinking about putting 30% of my monthly income into a CD, to pay my taxes out with. I am an independent contractor so I have to set aside part of my income anyway. Do you think this would be a good idea to do starting at a 6 month CD?

    • says

      I don’t think a 6 month CD rate is more than 0.5%. Given a savings rate is at 0.1%, there is a diff, but not much. It all depends on how liquid you are and how much cash you have lying around other tan the CD.

      If you know you don’t need that money in 6 months, go for it, as it’s better than just savings.

  17. says

    I’m doing a variable rate CD currently and the rate is not that great. It’s higher than a traditional savings account, but nothing to get too excited over. My biggest goal is to diversify so I plan to keep investing in the CD and can only hope for the best :)

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