Certificates of deposits, aka CDs have long been a stable part of my overall investment portfolio. Whether it was a bull market or a bear market, I would always invest roughly 20% of every dollar saved in the longest CD possible since college.
Although I lost around 35% of my net worth during the worst of the crisis in 2009, I knew that even if everything went to hell I’d have at least 20% of my net worth intact. The feeling was very comforting, especially when yields were over 4%.
Unfortunately or fortunately, times have changed as CD rates have continued to come down over the years. Rates have inched up about 0.5% since Trump’s presidential victory on expectations of higher growth and inflation. However, rates continue to remain depressed and will likely stay low for a long time due to economic slack, productivity growth, and technology.
As a result of lower interest rates for longer, everybody should AT LEAST:
1) Refinance their mortgages, call their credit card companies, and consolidate their student loans. Refinancing a mortgage or locking in a new mortgage at current low rates is a no brainer given rates are back down to two-year lows in 2019.
2) Look for higher returning investment opportunities in a risk appropriate manner.
3) Hunt for high yielding CDs and savings accounts online. Take a look at CIT Bank for one of the highest yielding savings account online. Their rates are regularly much higher than comparable banks.
Always Remember Everything Is Relative In Finance
When you have the 10-year treasury bond providing a ~2% return, your hurdle rate is very low. There is a good chance a monkey can randomly choose 10 stocks to build a portfolio that will beat these returns if history is any guide.
The dividend yield of the S&P500 alone is around 2% for goodness sake. The 10-year bond yield is the hurdle you need to beat to make an investment worthwhile. Otherwise, why bother taking any risk when you can earn ~2% a year risk-free.
My conservative investment target return has always been around 2-3X the risk free rate of return. With the 10 year treasury yield likely staying below 3% for a very long time, I’m shooting for a 4% – 7% annual return (2-3X the 10-year bond yield). The problem is, no CD provides even close to a 4% return. As a result, we need to move up the risk curve.
I’ve got a $330,000, 7-year CD earning 4% coming due, which I plan to reinvest to earn at least a 4% rate of return. I do not plan to renew the CD into another 7-year CD at a 2.4% rate for another 7 years due to the current economic environment. Here are the reasons why:
* Highest rate available is a 10-year CD at 2.5% yield.
* CDs yields barely keep up with inflation.
* Locking up money for 10 years for 2.5% does not sound appealing, especially with an early withdrawal penalty.
* If there is significant 3-5% inflation due to so much monetary easing, CD rates will rise, making it foolish to lock up money at lower rates.
* The S&P 500 dividend yield is around 2.3%.
* Chances are decent investors should be able to outperform a 2.5% return in many other asset classes.
* Real estate crowdfunding is providing a 8% – 12% return due to lower valuations in the heartland of America, which we can all take advantage of now through a company like Fundrise.
CD interest rates have declined with 10-year bond yields for 35+ years.
All this said, we’re also going into a time of uncertainty as stock market volatility has returned in 2018 so be careful!
CD Investment Alternatives
1) High Interest Savings Account. For those who are absolutely risk adverse, investing money in a high yielding online savings account is the safest move. You can earn 2.3% at CIT Bank today, which is incredible. The reason why bricks and mortar banks can’t offer as high of a rate than banks like the online banks is due to much larger overhead costs.
2) Peer-to-Peer (P2P) Lending. P2P lending has been around since 2006 and has finally started to go mainstream. The industry is regulated by the SEC and there are now loans worth over $10 billion in P2P land. After about 10 years of data, you can earn roughly ~7% in a portfolio of 100, A or higher rated notes. You’ve just got to be OK with borrowers occasionally welching on their debt.
3) The Stock Market / Dividend Stocks. Investing in the stock market is the riskiest CD alternative, but it’s also straightforward thanks to retirement savings vehicles such as the 401k, IRA, as well as online brokerage accounts. Investing in the stock market is not a comparable alternative to risk-free CD investing at all as we learned during the recession. That said, low interest rate returns on CDs force us to take more risks. So far, the S&P 500 has gone up by over 200% since February 2009. The question on every investor’s mind is: how much longer will the good times last?
20% of my net worth is in CDs because I’m content with 4% risk-free returns. 35% of my net worth is in real estate because although real estate is a fantastic way to build long term wealth, real estate is leveraged risk. No more than 35% of my net worth has ever been exposed to the stock market because the 1997, 2000, and 2009 implosions destroyed tremendous wealth and sent many friends to the poorhouse for going all-in at inopportune times.
The easiest way to invest in the stock market is through Betterment, the original digital wealth advisor that leverages technology to customize an investment portfolio based off your risk tolerance. It’s free to sign up and explore what type of investment portfolio they might build for you.
4) Debt Repayment Of Any Kind. It’s generally better to have less debt than more debt. If you have legacy debt that has a stubbornly high interest rate which cannot be lowered, then paying down debt is the safe alternative. Examples of legacy debt include student loans and mortgage rates at over 4% and any type of credit card debt, which averages above 12%.
A 4% mortgage interest rate might not seem like a lot, but when the current risk free rate is less than 2.5%, 4% is sufficiently high enough to pay down. Remember to always think in relative terms. Besides the economics of paying off debt, there’s also a positive mental benefit as well. I paid off my 2.75% business school loan debt early because I simply found the debt annoying. Getting rid of the burden felt tremendously satisfying.
Do note that refinancing your mortgage to a lower rate is considered debt repayment. During the refinance process, a bank literally pays off your entire existing loan and gives you a new loan with a better rate in its place.
See the latest mortgage rates with Credible. They have one of the largest networks of lenders who compete for your business so you can get the best rate possible. This is exactly what I did when I refinanced my mortgage in 2016. I used the written bids to make my existing bank match and beat their best rate!
5) Bonds / Municipal Bonds. Bonds have historically returned 3% – 5% and have also provided much less volatility than stocks. But bonds have also suffered from a decline in yields along with the long decline in government bond yields. If you are in a 28% or higher federal income tax bracket and pay state taxes, you may want to consider investing in municipal bonds, which allow investors to earn federal and state tax free income.
The risk of investing in bonds now is that Donald Trump’s policies may accelerate inflation, which would push down principal values. I’m personally buying a California municipal bond ETF, CMF, which provides a ~2.5% yield as part of my low-risk portion of my investment portfolio. See: The Case For Bonds: Living For Free And Other Benefits
iShares Aggregate Bond Fund (AGG) Historical Performance Chart
6) Real Estate Crowdsourcing. Investing in real estate in cheaper parts of the country is currently my #1 focus for where I’m allocating capital to build more passive income so we can stay retired. Instead of investing hundreds of thousands of dollars in one specific property, I’m investing $20,000 – $50,000 in various commercial or residential real estate crowdsourcing deals.
Real estate is expensive in coastal cities such as Los Angeles, Seattle, San Francisco, Washington DC, Miami, and New York City. Now that Trump has won, the Midwest, South and other inland cities should attract more attention and outperform relative to coastal cities. They already have much higher cap rates (rental yields) of 8% – 20% compared to just 2% – 5% in the coastal cities.
Surgically investing in lower cost, higher returning parts of the country is a much smarter move.
The average return for real estate crowdsourcing has ranged from 9% – 15% a year for the past several years. By building a diversified portfolio of 10 mid-market deals, I’m confident I’ll be able to beat the 4% CD return.
Saying Goodbye To CDs Is Not Hard To Do
With CD rates so low and alternative investments relatively more attractive, it’s hard to argue a strong case for investing in CDs anymore. Perhaps if you are super risk adverse, already in retirement, and have no other passive income whatsoever, CD investing is appropriate. However even then, a 70 year old can find greater returns in often criticized annuities.
Finally, I also strongly encourage everyone sign up with Personal Capital, a free online wealth management software to keep track of your money. I used to manually update my net worth in an Excel spreadsheet once a quarter. Now everything is done for me so I can spend my time analyzing my overall net worth and making sure it is properly balanced. My number one goal is to continuously grow my net worth in good times and in bad times. Nobody cares more about your money than you!
One of their best features of Personal Capital is the 401K Fee Analyzer which is saving me over $1,700 a year in portfolio fees I didn’t know I was paying. Personal Capital keeps track of my budget, highlights risks in my portfolio, and helps me keep a watch out for pesky bank fees. They’ve even got an amazing Retirement Planning Calculator using your real linked data to run thousands of algorithms to see whether your retirement goals are achievable. See how you stack up yourself! It takes only a minute to sign up and aggregate your accounts.
How is your retirement outlook doing? PC’s Retirement Planning Calculator
About the Author: Sam began investing his own money ever since he first opened an online 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.
Updated for 2020 and beyond.
Nice site to keep up on investing ideas. Your answers seem very reasonable kind of like a Dear Abbey for different reasons of course. Thanks.
I am looking for advice on how to find an investor to loan me $30,000 with my house as collateral which has a market value of $400,000 and a 1st TD of $250,000. I will pay top dollar in interest.
Payback guaranteed by auto bank payments. This can be a balloon due in 12 months if desired.
Depending if this loan will be first or second lien?
I am retired and raising my great granddaughter she is three years old what can I invest two thousand dollars in that will grow the most interest for her when she turns eighteen? I just want to make sure she has some money to help her ,I am all she has.please can someone help me as I know nothing about investing,thank you ,
A much better alternative would be to buy a high dividend paying stock and sell a deep in the money call a couple of months out. You get the dividend, premium from the option, and almost no risk to the downside. If the option gets assigned, that’s good because that means you made money and can simply redeploy the cash in another option. This method has a significantly higher return and less risk than only owning a dividend stock. Today, I purchased KMI (paying 8.5% dividend) and sold a call 30% deep in the money expiring in 2 months. Within 2 months, I will get at least 4.5% return as long as the stock doesn’t decline more than 30%. After 2 months, I will redeploy the cash into another Deep In The Money Covered Call. I’ve have been using this method for years and have never lost any money. It is an amazing way to invest Cash. The only drawback is that no matter how much the stock price increases, you cannot make more than the original amount.
How did the KMI covered call trade work out?
Yes, you may not get the dividend when the extrinsic value of the call option is less than the dividend by ex-dividend date as the stock will be called away on ex-dividend date. The other downside is the call and bid spread for deep ITM call could be quite wide. I just ran some numbers on KMI example that you mentioned. For instance the current KMI closing price is $20.42. 30% deep ITM is approximately at $14 strike price. This call option mid price with Sept 20 expiry for this strike price is at $6.375 (Ask/bid at $6.4/$6.15) and the intrinsic value of this option is ($20.42 – $14 = $6.42). Could you help us understand how you get 4.5% return in two months?
You make some interesting points, but I still invest in CD’s. FDIC insuring my money is enough, and rates can only keep going back up!
Good info!
How did you choose between Prosper.com and LendingClub.com?
I got to meet ip with Prosper representatives face to face a couple times in SF and therefore I went with them.
Hi Larry, I checked a couple credit unions here in SF, and some do have some good rates. I guess I can’t be bothered to physically open up an account given it’s so easy to open up an account online nowadays and transfer money. Call me 2013.
Not a bad place to park your money. Canadian CD / savings interest rates are higher than the US. Good luck!
What about an already mature Whole Life Policy? Many of the mutual companies (150+ Yr companies) are paying 5 to 7% dividends that (when used correctly) could be tax free.
Not sure Evan about whole life policies as I don’t have one. If you can get 5-7% tax free dividends, then that is huge. There must be a catch though.
Sam, have you written an article to compare the various brokerage accounts? I’m curious what you find in Etrade as compared to the alternatives. I haven’t used Etrade myself but if they have good research, etc, I would consider switching. I’ve been considering making a switch for awhile but I really havent made the time to analyze the options out there. When I choose my account 8 years ago, I didn’t have much to invest so I just choose my account pretty much randomly.
Hi Andrew, I have not. I’ve used Charles Schwab, Ameritrade, and E*Trade. I’m currently on E*Trade which works fine. They are all quite similar.
Sam,
Thanks for the CIT Bank recommendation. A 1% yield is amazing compared to what BAC or WFC were offering. Next step, figure out what to do with the Vanguard Total Bond Fund, which everyone is saying is about to blow up.
Marcel
It’s sad, but true. Everything is relative!
Earlier you said you were not a fan of bonds. Have you considered a short term investment grade bond fund? Some of these have been paying 4%-5% over the past few years and with the short term duration, you will not be hurt that bad by an unexpected spike in inflation.
My Credit union has something different but also a great way to get a “juiced up” return.
You put $500 a month into a special saving account and they pay 4% interest on the amount in this account. This not going to make me rich but it’s a little extra “free” money.
You must check out government I savings bonds. They are bought online at treasurydirect dot gov and are guaranteed to protect your cash from the ravages of inflation. The interest payments reset 2 times per year in accord with the inflation rate!
Will do. US Treasuries have been selling off recently, and the 10-year yield is now at 2.02% as of 2/13. I wonder if we’re going to see a massive bond sell-off.
We are still investing in CDs, even at these low rates. Yes, they barely keep up (or not) with inflation. Yes, the income for after-tax CDs is taxed as regular income. Yes, there is no opportunity for growth with CDs. My portfolio is heavily weighted to CDs and MM funds, because I intend to step off the work treadmill very soon, and cannot tolerate the risk of a 10% (or more) haircut. I am happy to allow my portfolio to slowly erode in value over decades, while eliminating the chance of getting slaughtered by Fed decisions, profligate Govt spending, declining dollar value, irrational herd mentality, spring-loaded inflation, etc. CDs are my only option at this point in time.
Stocks, Bonds, Real Estate, Gold, etc. all have big downsides which have been discussed in prior FS blog posts (and as Sam stated elsewhere, are not comparable to CDs). The disturbing thing about Stocks is that there is no longer a correlation between the economy and the Equity markets; this break in reality and predictability has discouraged us from further investment. Some of the posters appear to be newer investors, and I would like to point out 3 things: 1) The S&P 500 (75% of US stock market) returned exactly 0.0% for 2011, less the dividend. Yet all that money was at risk. 2) The S&P 500 is lower today than it was in 2000, 13 years ago. 3) The NASDAQ is 60% of where it was in 2000; $1 invested 13 years ago is worth 60 cents today, less dividends.
Those 3 things may bounce off investors happy with a 100% run-up in the past 5 years, and I am not encouraging anyone to take my path. Just wanted to explain why CDs are the best deal for me. One more thing, btw, I don’t understand the need/desire to build an Dividend portfolio of individual stocks; there are plenty of low-cost Dividend/Value funds that do this very thing and require very little care-and-feeding.
Thanks for sharing your viewpoint. Each person’s situation is different and this choice let’s you sleep best at night, especially what you mentioned before regarding your portfolio loss during the downturn.
So many folks were making fun of me for allocating 30% of my savings to 4% yielding CDs when the markets were going up. They said I wouldn’t keep up with inflation. Well, I’d much rather have a 4% guarantee than lose 30% of my principal in the market that’s for sure. Losing out to inflation is different from losing money!
As I understand it you will end up paying ordinary income tax on your structured notes gains. Is that correct? I vaguely remember reading once that that has to be the case if there is principal protection or something like that.
You are also exposed to credit risk of the issuer (generally a bank), so without going into priority of payments if your expected return on structured note does not exceed debt of that bank that is maturing at a similar point, it is probably not a good idea.
Correct. If you think Citibank is going bankrupt, then you probably don’t want to buy structured notes from Citibank. But if Citibank goes bankrupt, the world will probably return to chaos.
Quicken loans was ok and they’re quite nice, but my credit union had a better Apr so we’re going with them. Except we’re also reducing the length of the loan, so our monthly goes up but overall (we plan to rent this place out when we buy another) we spend 30k less. Our original mortgage was last April!
Next up: REITs
I’m very curious about P2P. I’d love to hear your results if you go in that direction. Right now, even though it is not completely passive, I would invest in real estate. It is incredibly cheap in my area and there will always be a large pool of renters due to socioeconomic reasons.
Real estate is great, but it’s not comparable to CD income because real estate involves more work and leverage. I’m trying to keep things as close to apples to apples as possible.
I think it all depends on what you want to do with the money. I would only invest parts of my emergency fund or some short term savings in a CD (although a high yield savings account might be a good alternative). Otherwise, I’d stick to dividend paying stocks.
I’m a little bit leery of P2P lending and wouldn’t feel comfortable with any more than 10% of my money invested there.
If I was particularly wealthy, I would look into structured notes.
I was leery about P2P lending for the first 5 years until 2012. It’s SEC regulated, defaults have dropped, and there is data showing positive returns from 2009-2012 e.g. during the financial crisis.
I started to move some money into TIPS a few years ago. I have a Vanguard fund that yielded 6.78% (2012), 13.24% (2011), 6.17% (2010) & 10.80% (2009). So far this year, it is slightly negative, but overall I like it as an alternative to CDs.
I’m a big CD ivestor myself. I don’t have any maturities coming up soon but I will definitely consider pulling my money out when the time comes. I find structured notes intruiging and can see myself going that route as a replacement. I don’t have the patience to put together and monitor a dividend stock portfolio. Thanks for the tips Sam.
With rates this low it makes no sense to invest in a CD. I would much rather take the “risk” and invest in strong large cap dividend paying stocks.
Thanks for your suggestion on the bond ETF. Unfortunately, I don’t think such a bond is an appropriate replacement for risk free CDs. There’s too much risk in bonds IMO, especially at current low rates. I can’t see bonds in general climbing much higher.
I’m bullish on equities and expect bonds to underperform or lose investors money as the great rotation towards stocks occurs.
Hey Sam, I was wondering if you ever spent time looking at the human capital websites like upstart.com. I have been poking at them and I think I like p2p lending more, but extra discussion on the subject couldn’t hurt.
-Doug
Sorry Doug. Haven’t looked into upstart. I like how payment is capped, regardless of your success. However, if one has the capital, best to capture 100% of the upide if you’re putting in 100% of the effort. Thx
This makes a lot of sense. I have not put money into a new CD in years. My focus now is in low-fee mutual funds for my retirement account, more risky equity investments in my shorter term investment account, and a nice cash cushion for whatever might come up next.
From your list, I like structured notes. I don’t know much about it, but it sounds like safe investment. Peer to peer lending and stocks are much more risky than CD.
I’m not investing in any new CD either. The rates are just too low. I’ll wait until the rate is better to buy some long term CDs.
I was considering putting some money into CDs mid-last year until the fed announced they were keeping rates low for so long. Now I’m trying to divert as much money as possible to the markets and to build up my P2P lending portfolio.
Sam I agree on your statement, but unfortunately we are all Pavlov’s dog doing what the FED expects us to do. With CDs of mine coming due I may still put some into CDs. Just a very limited amount.
No mention of I-bonds??? No dividend stocks?
MLPs are part of my portfolio for income, but don’t think it’s a good time to get into them now. I’ve seen 100% appreciation (this does even include the income) in the MLPs I own current so it’s a very crowed space (like all income producing products)
REITs also as well, but not in taxable account.
I’ll mention I-bonds, I have over $200,000 worth of them. I purchased over 10 years ago and my fixed rate is 2 to 3.6 percent. Thus over the
Ast few years I have been getting 5 to 7 percent interest.
It’s great you got them I-bonds 10 years ago David. However, I just don’t feel comfortable with buying a lot of bonds of any sort now.
I absolutely agree!
I bonds now only return inflation – with no fixed amount above that.
All other bonds – the risk to reward ratio just is not there in this low interest rate environment.
I agree, and would recommend an investment like Kinder Morgan (KMI) over a CD. (But not the Master Limited Partnership (MLP) Kinder Morgan (KMP), due to the K-1 tax form requirement).
KMI increased its dividend to $0.37 for Q4 and $1.40 for the year, ahead of even the revised budget of $1.35 for the year. At it’s last close and annualizing that $0.37 to $1.48, the forward yield is 3.96%! Way better than a CD, and not even considering that this dividend should rise over time.