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5-Year CD Verses 7-Year CD, Incremental Return

Friday, April 5, 2013 - 12:27 PM
This Q&A exchange from a recent Scott Burns column may be of interest to
a few:

   Q. If you had several CD's maturing and no need of the money in the
   foreseeable future, which would you choose? A 5-year CD at 2.15 percent
   or a 7-year CD at 2.70 percent? I am tempted to go out 7 years, as
   interest rates don't seem likely to be going up any time soon, but I
   would like your thoughts on which you would choose. —J.F., San Antonio, TX

   A. Go for the 7-year CD. One way to look at this is to ask how much you
   are being paid in each of the two additional years— years six and seven.
   If you total the expected interest for the 2.70 percent 7-year CD and
   subtract the 2.15 percent interest on the 5-year CD, it turns out that
   you are, in effect, earning at about a 4.075 percent interest rate in
   each of the last two years.  Not bad.

   This is based on measuring what economists would call your “incremental
   return” when you add two years to the maturity of the CD. While the
   additional yield is spread out over 7 years, you would not get it without
   committing the additional two years. So your effective yield on those
   added years is materially higher.

Full column here

Incremental return = (7*2.70 - 5*2.15)/2
cumuluscumulus363 posts since
Jan 16, 2010
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