Certificates of deposits, aka CDs, are now paying extremely low rates in the new decade because the Fed slashed the Fed Funds rate to 0% – 0.25% earlier in 2020. As a result, it’s a good idea to look for CD investment alternatives to potentially earn higher returns.
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. The goal was to not only have some risk-free assets, but to eventually get neutral real estate by buying a place to live.
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%.
As a result of lower interest rates, everybody should AT LEAST:
1) Refinance their debt. Refinancing a mortgage or locking in a new mortgage at current low rates is a no brainer given rates are back down to ALL-TIME lows thanks to the flight to bonds. Credible is my favorite lending marketplace to get pre-qualified lenders competing for your business for free in under three months.
2) Look at CD investment alternatives. Instead of earning almost nothing in a CD, look at various passive income investments instead.
3) Search for higher online savings accounts. It’s interesting, but money market accounts are often paying higher than CDs. If you want a place to keep your risk-free money, then look at an online bank like CIT Bank. It consistently has one of the highest yielding savings account online.
Always Remember Everything Is Relative In Finance
When looking at CD investment alternatives, it’s good to realize everything is relative in finance.
When you have the 10-year treasury bond providing a <1% 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 1.5% 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 1% 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 2% for a very long time, I’m shooting for a 4% – 6% annual return (2-3X the 10-year bond yield). The problem is, no CD provides even close to a 4% – 6% 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 1.25% yield.
- CDs yields barely keep up with inflation.
- Locking up money for 10 years for 1.25% 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 1.5%.
- Chances are decent investors should be able to outperform a 1.25% return in many other asset classes.
- Real estate crowdfunding is providing a 8% – 12% return due to lower valuations in the heartland of America.
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 1% at CIT Bank today, which is incredible given the 10-year bond yield is only at ~0.5% as of 1H2020. 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) 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.
3) 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!
4) 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
5) 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. My favorite platform is Fundrise. It’s free to sign up and explore.
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.
The average return for Fundrise platform investors has ranged from 9% – 11% a year for the past several years. During times of stock market volatility, Fundrise diverse eREITs tend to outperform. You can click on the chart to learn more. It’s free to sign up and explore.
Saying Goodbye To CDs Is Not Hard To Do
With CD rates so low, we must look for CD investment alternatives. 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!
Updated for 2020 and beyond.