Boring: CDs vs bond mutual funds

[VagabondMD]

This is going to be a very boring thread involving small return percentages, and it might not be up your alley. So be warned!

Our business/personal banking relationship recently offered us the following advertised CD rates:

1.03% 11-month and 1.76% 48-month "one bump"* (one bump meaning that during the course of the 48 months, should interest rates rise, you have one opportunity to "bump" to the new, higher rate)

I probably keep more cash around than I should (mostly at Ally, in a MM fund, at 0.85%; some in my checking account at the local Bank at 0.35%). When I saw the rates, I committed to moving cash into both and sent an email around to my partners as a PSA.

Afterward, one partner specifically asked me why I keep cash in banks and CDs. His solution was using the Vanguard Treasury Mutual Funds (short and/or intermediate term). The Vanguard Short-term Treasury Mutual Fund has a current yield of 0.54% and a duration of 2.39 years, and the Intermediate-term Treasury Mutual Fund has a current yield of 1.15% and duration of 5.38 years (data per Morningstar). Again, the 11 month CD has a yield of 1.03% and the 48 month 1.76%, with no risk or fluctuation of principle, while the NAV of the mutual fund can be eroded in a rising interest rate environment. My analysis suggests that in a stable or rising rate environment, the CD is the better opportunity, and if rates decline a little, it is, at worst, a wash compared with the mutual funds. Where did I go wrong?

[phw]

imho, as long as you're confident that you do not need liquidity within the time period of the CD, then it seems great!  CD's are for when you need short term money (1-5 years), and you're *sure* you won't need the money before maturity.  If your time frame is longer, it's possible to take more risk and seek better returns with equities and such.  If it's possible that you might need the money before a CD maturity date, then either keep it in a FDIC bank account or in some type of short term bonds.
I currently have money for a house down payment split between a CD (about to mature) and BSV and BND.  When the CD matures I'm tempted to put it all in the bond funds because they've been doing really well this past year....but I know better.  This is just my recency bias, so it will all probably go in a savings account to wait out the last 6-18 months before I need the money. I can't put it into another CD because I'm not really sure when I'll need it again.

[Zaphod]

Vagabond MD wrote:

This is going to be a very boring thread involving small return percentages, and it might not be up your alley. So be warned!

Our business/personal banking relationship recently offered us the following advertised CD rates:

1.03% 11-month and 1.76% 48-month “one bump”* (one bump meaning that during the course of the 48 months, should interest rates rise, you have one opportunity to “bump” to the new, higher rate)

I probably keep more cash around than I should (mostly at Ally, in a MM fund, at 0.85%; some in my checking account at the local Bank at 0.35%). When I saw the rates, I committed to moving cash into both and sent an email around to my partners as a PSA.

Afterward, one partner specifically asked me why I keep cash in banks and CDs. His solution was using the Vanguard Treasury Mutual Funds (short and/or intermediate term). The Vanguard Short-term Treasury Mutual Fund has a current yield of 0.54% and a duration of 2.39 years, and the Intermediate-term Treasury Mutual Fund has a current yield of 1.15% and duration of 5.38 years (data per Morningstar). Again, the 11 month CD has a yield of 1.03% and the 48 month 1.76%, with no risk or fluctuation of principle, while the NAV of the mutual fund can be eroded in a rising interest rate environment. My analysis suggests that in a stable or rising rate environment, the CD is the better opportunity, and if rates decline a little, it is, at worst, a wash compared with the mutual funds. Where did I go wrong?

Click to expand...

Those rates are lower than a couple months ago arent they? I though they were near 2% for a little bit. You might want to wait as the 10y looks to finally start cracking to reality, it diverged from the fed funds rate and paradoxically shot lower fearing a recession. However, we are clearly not and inflation looks to be increasing, etc...so rates may go up and correct somewhat quickly, but this may only be a few basis points in a cd, but could be 25-75.

Otoh, its highly unlikely that rate hikes will happen with the frequency or to a high enough level that it makes much of a difference on those other investments and you could put a premium on liquidity. Hard to say, but I wouldnt lock up a 5 y at these rates. Best to wait for some kind of scare or overshoot of the rate and strike then in longer term issues.

[Hatton]

The rates seem ok. I started keeping cash equivalents only recently outside of the working capital in my practice.  Rates have been so low for so long that I just leave the money in checking. At one time I kept a years worth of tax estimates and malpractice premiums in t bills.It was too much trouble.  My personal emergency fund is split between vanguards money fund and a short term bond fund. The only investment my father was comfortable with was CDs so when he died he had them scattered at 4 or 5 banks.  There is no penalty in the case of a death.  I have never used CDs myself.

 

 

 

[VagabondMD]

I made the move. I tend to keep a robust emergency fund and cash cushion (about three years of living expenses), and I thought that having these CDs for a good chunk was better than splitting between the 0.85% in the Ally Money Market and 0.35% in my checking account. I am not going to get rich, but I will squeeze a few extra bucks out of it. I am not interested in using a bond mutual fund for this purpose; I just do not want the potential for loss of principle.

[amphora]

Kind of confused why you would buy an 11-month CD with 1.03 % yield when there are many savings accounts with 1% or higher yields. With a savings account you have more liquidity. The only reason to get an 11-month CD is if you're concerned rates are about to plunge.

[Zaphod]

I assumed he was considering the 48 month option only, as there are savings accounts higher than that. Also, cant go without mentioning that even if it appears you are not losing principle, inflation still chips away at it, but of course its much safer than anything else and low right now.