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CDs versus government bonds

I’m 70 and still working. I have about 700k in savings and CDs, home is paid off and I plan to retire in a year.

I am considering putting a portion of the $ into long-term CDs since the interest rates are near 5%.and relatively safe.

I figure if the worst possible scenario happens, I can always withdraw from the CDs and pay the penalty, From what I understand government bonds could be less forgiving in that if the interest rates fall I would have to sell the bonds at that price.

I just want to have some extra income coming in after I retire and am tempted to invest in 5 or even even 10 year CDs.

Any advice would be appreciated.


Comments

  • Just don't put all of your eggs in one basket. 5% guaranteed is pretty damn good. DO IT. Keep at least 50% in safer market instruments. Maybe funds, rather than in single stocks. Look at BRUFX. and MAPOX.
  • edited March 2023
    Don’t know about your finance situation and risk tolerance. So here it goes for your questions on CDs:

    1. As of today the only CDs that yield 5% are those with shorter duration ones, 9-12 month. Creating a CD ladder is necessary in order to maintain cash flow (income) as you desired. For example, a one-year ladder consisting of 4 CDs with each maturing every 3 months would provide income every 3 months. So it boils down to how much extra income you want from your CDs. Don’t forget that the interest accrued from CDs is taxed as ordinary income with both federal and state tax applies. Treasury bills/notes are federal tax-exempt but state tax is still applied.

    2. CDs are safe (FDIC insured) but they are not liquid during the investment period. Some bank CDs pay interest monthly, but they pay at lower yield. Brokered CDs at your brokerages pay higher yield, but majority of them pay at maturity, not monthly. Treasury bills (1 -12 months), on the other hand, are highly liquid and one can sell them on secondary market if necessary. Creating T bills ladders will provide periodic income just as CD ladders.

    3. At current inflation rate (CPI as of Feb 2023 is at 6.2% y-o-y), you are losing future buying power each year by investing in CDs alone. Thus, other investment vehicles such as stocks, bonds, and others are required as part of the “growth” component of your retirement income.

    Within this MFO discussion forum, you are getting opinions from other investors. The best answer should come from your financial planner. At least you have something to consider as a starting point. Best wishes.
  • The penalty for brokerage CDs can be very substantial, compared to the penalities for Bank CDs. I am very hesitant to give advice to any other poster--circumstances and situations vary. My wife and I are retired and in our 70s, and I will say I recently spoke to a Charles Schwab income specialist, and he was recommending a mixed bag of income options, including a ladder of CDs/treasuries/MMs, and taking into account liquidity issues. Since I do not know where you invest, and other details, I would not be willing to say much more. Best wishes!
  • Will you receive a pension when you retire ? Of the $700 K , is any in equities ? Have you ran any simulation to project income to out going bill payments ? Any thoughts of down sizing after retirement ? How much income from SS? More questions than answers, & hopefully they will lead you as to how much to have in "safe" investments.
  • edited March 2023
    Before doing this investment analysis, it’s worth doing a budget analysis of how much you’re spending per month or anticipate spending. Are you alone, married, have any relatives that might need financial assistance or provide financial assistance if you need it? What sort of medical bills do you have? Do you have any insurance policies like long-term care insurance to help with care should you become incapacitated? Are you planning any big trips? It’s worth figuring out what you expect your monthly and annual expenses to be before figuring out how your portfolio should be invested.
  • msf
    edited March 2023
    With respect to directly- (bank-) sold CDs, Ken Tumin at depositaccounts.com has a cautionary note:
    Some banks and credit unions have language in their CD disclosures that allows them to refuse an early withdrawal request. Although CD early withdrawal refusal by a bank or credit union is rare, it is possible. Review the CD disclosure for this type of wording.
    https://www.depositaccounts.com/blog/2019-study-cd-early-withdrawal-penalties-changed.html

    He reports finding typical early withdrawal penalties averaging around 1 year's interest on a 5 year CD. Tolerable I suppose if you hold the CD for at least half way. The piece was written in 2019; I doubt penalties have gone down since then.

    Broker-sold CDs can be harder to get out of. This is usually done by selling them on the secondary market. The CDs are thinly traded and one risks losing a lot by selling early.

    Either way, with bank failures more than a theoretical concern now, you should probably check into the financials of the bank you're thinking of using. While a CD and its accrued interest is insured, should the bank fail, your rate going forward might be reduced. This isn't a concern for short term CDs. However, you're looking to lock in a rate for many years, and that could be stymied by a bank failing.
    https://publicintegrity.org/inequality-poverty-opportunity/when-banks-fail-so-do-those-promised-cd-rates/

    Buying a CD (for some of your money) is not a bad idea, you just need to exercise care.

    ---

    I think you (OP) meant that if interest rates rise and you need cash, selling a bond could result in a significant loss. Just look at what happened at Silicon Valley Bank.
  • Our Social Security benefit is 55k per year. Home is paid off and no debt.

    We live pretty frugally - pretty much homebodies (boring you could say).

    I have just started to calculate how much we will spend including Medi-Care, taxes etc.

    We have no equities - all in CD’s and Money Market. I don’t have the stomach for the stock market.

    I did come across a 5%, 5 year CD with this credit union. It seems to be well established and the early withdrawal penalty is better than most. It’s supposed insured by the government. I would appreciate your opinion on it. Most other institutions are in the 4.5 range.

    https://allincu.com/

    All In Credit Union - 5.00% APY
    Term (months): 60
    Minimum deposit: $1,000
    Early-withdrawal penalty: 3 months of interest
    Membership: Anyone can join All In by signing up for a free membership in the Fort Rucker/Wiregrass Chapter of the Association of United States Army, keeping at least $5 in a savings account, and paying a one-time fee of $1.

    I’ll look into CD and Treasury ladders as I don’t understand the advantages over regular CD’s but it would seem those exempt from federal taxes would/could make a big difference.

    Thanks for all the feedback!
  • "I did come across a 5%, 5 year CD with this credit union."

    @Jan- a bet on a long-term CD at a high interest rate has it's own risks for the issuing credit union or bank, and that risk is sort of the opposite from what took down Silicon Valley Bank recently. If the Fed's interest rates come down in a year or two that issuer will be stuck paying out at a high rate but itself having to invest for income at a lower rate. Do enough of that sort of thing and that ain't so hot either.
  • edited March 2023
    @Jan : Also most "Fed" government bonds are state tax exempt in most states, not all.
  • @Old_Joe. +.1. Your remarks about the possible hazard of a 5 year CD @5% in the face of declining rates are insightful. And loading up on such counting on the FDIC is an example of a moral hazard.
  • msf
    edited March 2023
    Old_Joe said:

    a bet on a long-term CD at a high interest rate has it's own risks for the issuing credit union or bank, and that risk is sort of the opposite from what took down Silicon Valley Bank recently. If the Fed's interest rates come down in a year or two that issuer will be stuck paying out at a high rate but itself having to invest for income at a lower rate.

    I don't see the situations as symmetric. Banks borrow short and invest long. The risk they voluntarily assume is being locked into more depreciating long term investments (as rates rise) than they have in short term deposits (solvency issue) and experiencing a sizeable net outflow of short term deposits (liquidity issue), notably a bank run.

    When Jan buys a CD, the bank invests that money long term. That long term investment will pay enough to service Jan's CD. When Jan's CD matures in five years, the bank will have to come up with the principal. Assuming that interest rates drop in the future, the bank's investment will have appreciated. So the bank will have no problem repaying Jan.

    To address larryB's moral hazard comment - it's generally not a long term deposit that creates a problem, since the bank has locked in its own return. There's no mismatch.

    Rather, a mismatch comes about when old short term deposit money (getting low interest) leaves and is replaced with new short term deposit money earning higher yields, while the bank is stuck in ongoing investments with lower yield.

    FWIW, the mutual savings bank and S&L crisis leading to institutions offering unsustainable deposit rates (including CD rates) was triggered by a unique set of conditions including:
    - artificially low deposit rates (until CDs were created in 1978 and the 1982 Garn-St Germain Act created MM deposit accounts);
    - disintermediation (people pulling money out of bank accounts to invest directly in Treasuries and newfangled MMFs);
    - restrictions on these institutions limiting their investments largely to lower yielding fixed rate mortgages; and
    - massive deregulation (allowing the institutions to act recklessly while being insured).

    So while there's a superficial resemblance to the situation OJ described - banks paying higher interest rates on new deposits than they're earning on their portfolio - the S&L situation was different, with rising rather than falling rates underlying the mess.

    FDIC history, The Savings and Loan Crisis and Its Relationship to Banking
    FDIC history, The Mutual Savings Bank Crisis
    Federal Reserve history, Garn-St Germain Depository Institutions Act of 1982
  • "Do enough of that sort of thing and that ain't so hot either. "

    I didn't mean to suggest a direct symmetry. Just pointing out that a major imbalance in bank/S&L income vs outgo, if carried on long enough, is likely to result in problems of one kind or another. My confidence in bank/S&L executives to recognize, anticipate, and effectively avoid such situations is, to say the least, minimal.
  • Bouncy bouncy. 4m T's back to 5%, 6m 4.92% at the close.
  • Thanks for heads up. Bought some T bills several weeks ago before SVB failure.
    Right now, CDs are paying a bit higher than T bills.
  • edited March 2023
    Right, CDs are paying a bit more, but factoring in tax equivalency and risk, for me it's pretty much a coin toss. Not buying either at the moment. (4.9-5.0 seems to be the top of the range for shorter maturity Ts right now, at least until something shifts in inflation/recession/bank trouble expectations.)
  • "it's pretty much a coin toss"
    Yep.
  • In trying to focus on what Jan is considering, for her personal situation, I don't see much risk. She sounds like a very conservative low risk investor, and putting a portion of her savings into a credit union CD, with government protections, appears to be a solid "safe harbor" option. She appears to be following an investment approach that is consistent, and one she understands. Whether she will continue this strategy, when her credit union CD matures, is just conjecture, and likely fodder for a different thread.
  • Another possibility for a "safe harbor" option, if someone is etf savvy is the treasury floating rate ETF, USFR paying 4.79% now. It is all treasury bills with a duration 0f 0.02. In addition it is state tax free with 100% t-bills. This has worked well for me in this rising interest time but it can be bought and sold anytime without cost in most brokerages. I also own t-bills but USFR is hassle free if you do not wish to constantly roll over the t-bills on your own. I do not use the Fidelity rollover program because I prefer to be able to change each duration if appropriate when each matures and of course you do not pay the 0.15 ER of USFR in buying the t-bills themselves.
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