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Why CDs Can Still Be Better Than Bonds

Tuesday, August 20, 2013 - 6:36 PM
From CBS MoneyWatch (by Allan Roth)
These days, I am often advising clients to put a greater percentage of their fixed income into bond funds than I have in the past. I'm also using certificates of deposit a bit less. Here's why and what it means to you.

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Ken TuminKen Tumin5,472 posts since
Nov 29, 2009
Rep Points: 125,708
1. Wednesday, August 21, 2013 - 6:48 AM
I seriously disagree with this idea that bonds are a better investment now. (BTW, that's what the story says, not that CDs are better, as your headline says.) Absolutely "no" in the face of the inevitable rise in interest rates, very likely starting by the turn of the year. And while we will have to see how quikly interest rates will rise, they eventually should be going up substantially, and the slower they go up, the longer that impact on bonds will be going on.

What you must understand about bonds is that every time interest rates tick up, the value of bonds you are holding goes down. Yes, if you hold the bonds until they mature, you will actually get that rate (if the issuer has not gone into bankruptcy!). But of course, the bonds that give the better rates today are the longer term ones -- and if you hold them for that long a term, you will not think that rate was very good by the time they mature. Yet if you sell before that, you will have to do so at a great discount if interest rates have gone up since you bought -- meaning you will not really get that yeild you bought at because your principle will be undermined. 

What this means is that bonds are just about to be taking a blood bath. And it could be a prolonged bloodbath. To get back to normal, the Fed rate has to go up more than it ever has before, and every time it or other market interest rates tick up, the value of your bonds will go down. 

This is why investors have been fleeing bonds now, before the bloodbath. The smart move now isn't to get into bonds and lose everything, but to get out and run for the hills. Bonds will be the hardest hit of all investments in the face of rising interest rates.
me1004me1004373 posts since
Jan 16, 2010
Rep Points: 2,600