Where's The Sweet-Spot In CDs These Days?

Bozo | May 27, 2017 | 1,375 posts since 2011

For those with a CD ladder, it's academic. A rung matures, you grab the best deal you can find to fill the maturing rung. It's entirely different when you have a CD maturing which is "outside" your ladder. Then, you are faced with a quandary. In a rising-rate environment, what's the best "bang for your buck"?

In my IRA CD ladder, I've always been a fan of 5-yr CDs. In my after-tax CDs (which are not laddered), it gets complicated. Should I reach for the best yield and go long, or accept a more modest yield and a shorter term?

Background: My rule-of-thumb has always been roughly 20 - 25 bps in yield for each additional year in term. If I can make 1.05% on a garden-variety savings account (which I can and do), then I should search for a tier as follows: 1-yr CD 1.25%, 2-yr CD 1.5%, 3-yr CD 1.75%, 4-yr CD 2%, 5-yr CD 2.25%.

Analysis: For some bizarre reason, the math breaks down at the 2-yr CD level. I can obtain roughly 50 bps over the yield I might expect (2% versus 1.5%). However, when I move into the 5-yr CD range, I get closer to the yield noted above in "background".

Issue: Have I already answered my own question? Is not the 2-yr at 2% the "sweet-spot" these days, when factoring in term and yield? In a rising-rate environment, we don't want to get too far over our ski-tips, with respect to the term of a CD, but we want to make a respectable yield. Is the 2% 2-yr CD optimal?

Your thoughts?

6

Kaight | May 27, 2017 | 1,192 posts since 2011

I've always been more a "barbell" person than a "ladder" person. For the short end of my barbell the recent AgFed 1.55% 30 month no penalty was a Godsend. I poured in as much money as I could muster at the time and continue to be without any regret at all. And of course if regret does surface I can take the money and run at any time whatsoever.

I do have a foible in my CD investing strategy which is not a point of pride. I don't take advantage of Ken's "pay the EWP" offerings. I don't like the idea of planning on early withdrawal, though I admit readily the strategy must be a moneymaker for many of Ken's readers. Still, it is unappealing to me. And it's not Ken's warnings, either, which put me off, though I respect the wisdom behind such warnings. As I said it's just a personal foible, a personal preference if you will, and not one I can easily defend.

Anyway, as a barbell person, most of my short money is today either at AgFed or with a few other CUs paying a bit more but quite short, while my long funds are spread across an array of 3% CDs. I really have nothing above 3% right now.

As for the "sweet spot" concept, let's say 2% for 2 years, I challenge each such offering with the following: would I surrender 1.55% money, locked in and guaranteed for a long time, and to which I can have access at any time without penalty or hassle, for (whatever) alternative opportunity? I think a 2%/2yr CD would be right on the edge for me. I really would like a bit more yield.

2

gbtexas | May 27, 2017 | 78 posts since 2013

I'm sorry, but your approach to a CD ladder vs your referenced sweet spot doesn't really seem to outweigh the arguments and logic for the often discussed laddering method. Over an approximate 30 or so years that I've been buying CDs, I've used several methods and hands down the 5 year laddering has far outweighed other attempts, including the use a sweet spot way of life. And there are multiple reasons for this.
With this being said, I fully understand why you would recommend what you did. However for any and all who would like the ongoing challenge of trying to to find the best relative yield vs the best actual yield then I say to have at it. Also it always comes down to the amount of time one really wants to spend, the amount of $ you have in total and at some given point and the number of dollars to be put in each certificate.

5

NeilStanley | May 27, 2017 | 62 posts since 2013

Here is one thought. With higher yields available today and longer-terms yielding more than shorter ones, why not get a CD that works like a bond? It was introduced and discussed here in 2013... https://www.depositaccounts.com/blog/2013/02/early-withdrawal-bonus-new-cds-will-give-savers-more-options.html

The audience might like to know that in the last four years since this product has been available even with interest rates rising somewhat it the last year, the redeemable account yields from one financial institution for 6-month holding periods averaged 1.63% while their 6-month CDs averaged .48% during the same period. On a $100,000 investment over four years it amounts to $4,600 more earnings for engaged depositors who are using this redeemable deposit product.

1

Bozo | Jun 6, 2017 | 1,375 posts since 2011

NeilStanley, with yields on the Ten-Year Treasury tanking since mid-March, the concept of getting a retail CD which acts like the Ten gives me shudders. Who would want the NAV on a retail CD to tank when interest rates go up, or increase when rates tank? One would just have morphed the retail CD into a brokered CD.

Thanks, but no thanks.

3

NeilStanley | Jun 7, 2017 | 62 posts since 2013

Good points on the redemption value declining in a rising rate environment. But, why as a depositor would you be troubled by the redemption value rising? Keep in mind that there is no utopia with conventional time deposits that have arbitrary early withdrawal penalties with no financial basis. A 6-month early withdrawal penalty or any other static penalty is arbitrary. It has nothing to do with the financial consequences of the early withdrawal. The redemption value of these CDtwo accounts are based on the actual financial impact of early withdrawal. I am sure you can see the reasonableness of having penalties and bonuses align with consequences and benefits.

When interest rates rise, the early withdrawal penalties are larger, but the reinvestment opportunities are greater too. So, the depositor with a market rate penalty is not excessively punished in a rising rate environment, they can hold on to their contract or cash out with a financially reasonable penalty. To be clear, we are not talking about callable CDs. Any early withdrawals are determined solely by the depositor. Bozo, you are obviously quite knowledgeable and comfortable with conventional retail CDs. That is good. However, if you consider the entire fixed income investment market place, there is a reason that the market for conventional CDs has shrunk while the market for bonds has grown dramatically. The structure of bonds is more efficient and effective for the investor because of the upside it offers that conventional retail CDs don't. If you don't personally want to have the upside options, I can respect your choice. But, that does not mean that others don't want them once they understand them.

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