Comparing Total Returns of Top CD Offerings with an S&P 500 Index Fund Investment
Many financial planners will stress how important it is to invest in stocks for long-term growth. If you’re going to invest in stocks, you will have to be prepared for risk and volatility. We saw this back in 2008 and 2009 when stocks plummeted. You may not want to invest all of your savings in CDs, but for the part you want to keep safe, CDs can offer reasonable gains without any risk. And if you use DepositAccounts.com to find the best deals, your CD returns can be improved without any additional risk.
Last December I thought it would be interesting to compare an investment in select leading CDs featured on DepositAccounts.com with a stock market investment. A chart was generated to compare these two investments starting around the time when this blog started in January 2006.
The first investment was $100,000 in the Vanguard S&P 500 Index Fund. The indicated performance includes appreciation and dividend reinvestment. Note that for the sake of this analysis, it is assumed that the investor held only this single index fund throughout the time period.
The second investment was $100,000 in select CDs. Instead of using past average CD rates, I chose CDs that were nationally available, had top rates, and were featured prominently on DepositAccounts.com at the time. For simplicity sake, the first CD I chose was offered at Patelco Credit Union in January 2006. It had a 5.00% APY and a term of 12 months (I could have also selected a longer-term CD with a reasonable early withdrawal penalty or a more liquid savings or money market account with comparable rates and achieved similar results). At the 12-month mark, the PenFed CDs with a 6.25% APY became available, and many of our readers jumped on the opportunity. Consequently, the second CD I chose was a 7-year PenFed CD with a 6.25% APY. This 7-year PenFed CD would have matured at the end of last December. To continue this comparison, I had to choose another CD, and PenFed made it easy with its CD specials that came out last December (another one that many of our readers jumped on at the time). One of those CD specials included a 7-year CD with a 3.04% APY. That is the CD used to cover the period from January to the present time. Below is a summary of the three CDs used for this comparison:
- Jan 2006 to Dec 2006: 5.00% APY 1-year CD at Patelco CU
- Jan 2007 to Dec 2013: 6.25% APY 7-year CD at PenFed
- Jan 2014 to Jul 2014: 3.04% APY 7-year CD at PenFed
Note that each of these CDs was nationally available and well featured here at DepositAccounts.com at the time. By being more active than the investor in the above example and by utilizing other local CD deals, special promotions and bonus offers, and reward checking accounts, the savvy deposit accounts investor could likely even beat these returns. In fairness, though, if one’s timing didn’t line up to invest in the 7-year Penfed CD at the time, one would have had to work harder to match those returns, especially in the latter two years of the 7-year term.
With the above disclaimers on each of the two investments, the chart below compares the returns of the above CDs with the Vanguard S&P 500 Index Fund (including dividend reinvestments) over the course of the approximate life of this blog – from January 2006 to June 30, 2014 (end of most recent quarter):
Since the last comparison in December, the S&P index fund’s lead over the CDs has grown. Without any significant stock market corrections this year, the index fund performance has been strong. The CD investment is growing more slowly than it did in previous years due to the maturing in December 2013 of the old high-rate CD. The new CD rate is less than half of the old CD rate.
Even with the big stock market gains over the last couple of years, the total return of the CD investment is pretty close to the stock market investment. The primary difference is that the CD investment only grew and never placed capital at risk. The value didn’t plummet like the S&P index fund did in 2008 and 2009. Additionally, most people will not have been able to match this type of market performance (a steady hold of VFINX), although in fairness, only the attuned CD investors or active deposit accounts investors will have been able to match this CD performance.
The stock market may continue to lead the top CDs for several years to come, but stock market downturns will inevitably occur. Those downturns may not be as severe as the 2008-2009 downturn (or they may be worse), but the downturn may be large enough that the CD investment will take the lead again. Even if the CD investment never again takes the lead, though, at least the CD investor can sleep at night knowing that the CD principal is federally-insured and never at risk of plummeting in value like the stock market investment is.
For those dedicated deposit investors (and those who participate meaningfully both in the market as well as in deposits), what has been your experience over this time period? Which investment do you think will perform better over the next 8-9 years? Please share your experiences and opinions in the comments section below.
I basically agree with your analysis I think that the issue of taxation must be considered.
Long term capital gains are taxed at a maximum rate of 15%-----C/D interest is taxed
at your regular rate (as high as 39%).
However,sleeping well at night IS very valuable--perhaps the correct approach should
be a base of C/D's combined with stock investments to try to keep up with long term
Please keep up the great work that you do.
Do you realize that a 20% stock allocation is less risky over time than a 0% stock allocation? Bonds/CD's have various risks, too.
Not losing a penny ever is kind of overrated.
With that said, it should be noted that comparing CD returns with S&P 500 returns is like comparing apples to..........****drivers.
Any good financial planner will tell you that CDs and stock market index funds should be used to fill different needs in an individual's portfolio. Both may be right for some people, while others should only have CDs (or other cash equivalents). Others, still, need the potential inflation-beating long-term growth that only the stock market can provide.
Rather than focusing on return, financial planners will tell you that it is more important to focus on what you investing goals and needs are and then back-fill the investments/CDs to meet thatose goals.
As a general rule, people who need their money for a specific goal that is within 5 years away should NEVER invest that money in the markets. The same is true for one's emergency funds. The potential volatility breeds too much uncertainty. However, for those people who are funding a long-term goal (such as retirement) that is 10-plus years out, the inflation beating growth potential of the stock market is needed. All of your money may still be there in your CD, but after inflation, how much stuff will your money still buy?
Thanks again, Ken, for the wonderful article. I truly enjoy numbers-crunching such as this. However, it is my belief that the information should be taken at face value. It would serve readers well to make sure they have a deeper understanding of why they are investing either in a CD or an index fund, and then make sure the choice meets the goals. Chasing returns or avoiding principal fluctuation when used in the wrong context can be dangerous!
How about comparing the 30 year TIPS market to the indexed s and p 500 index fund.
I think the point of the excercise is to show one is taking a lot of risk with volatility with the stock market if held for a short period of time. I would assume in all 30 year periods of history one would be better off in the stock market.
look at 1978-2008, stock market did pretty well!!
tough time for new retirees now
We have a 250K CD due in 538 days (yes, I track in detail). If the market has significantly "corrected" and I sense a "bottom" or the beginning of a "bull" market, I'll probably put the money in one or two index fund(s). We may never need the money, we may need it in 10-15 years, we can afford to lose it and index funds are more "liquid" than CD's with painful withdrawal penalties.
If, however, the same scenario develops and CD rates are above 5% we may opt to stick with CD's for safety. However, only long-term CD's (7-10 yr) pay the interest I want and they come with potential penalties. Regular CD's have withdrawal penalties while brokered CD's carry market pricing risk. Liquid, yes. Pain free, no.
Perhaps we will revisit a time when you could walk in to your local bank, plop down 200K and earn 5% on a 1-2 year CD. That isn't today, tomorrow or next year. Last year, we put 400K in 10-year brokered CD's at 3.3%; I ladder/invest the interest every six months. In nine years when the brokered CD's mature, we'll have to decide what to do with the 400K principal. A nice problem to have but still a problem. More CD's, stocks, index funds, pure cash, or monthly checks to the old folks home!
We have a combined annual income stream that allows us to increase savings each year which means we do not depend on investment income. Your investment mileage will inevitably vary.
Unless you are investing the funds to leave to your heirs, in which case you could begin gifting the funds to them, start spending it on yourselves or set-up a scholarship fund, for example. There are always nice things people can do if they have the "problem" that you do.
My prediction for the future? The economy seems to be slowly but steadily improving, so interest rates will probably keep rising slowly. Interest rates and stock prices don't seem to move in a typical fashion for an economic expansion (yet). Stocks may already have the full future extent of this bull market priced in, or maybe not. Inflation may come back due to the artificially low interest rates. So as a trend over the next several years, I expect higher interest rates and maybe lower, maybe higher stock valuations. Once we reach sufficiently high interest rates, I think long CD maturities will make more sense again (and the probability of further stock market gains becomes smaller). My guess is that it will take 2-4 years for rates to rise back to that level. Waiting to invest in a 5-year CD for that time of peak interest rates could be a decent 7-9 year strategy. The biggest issue, like in 2007, could be that it will be difficult to forecast inflation. Inflation-indexed bonds could become an attractive investment. But in summary, I really don't know. One thing I learned in my couple of years of investment experience so far is to not put my eggs all in one basket.