Real Estate
January 17, 2018
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The current CD quandary

By: Ken Weise
September 22, 2017

Economists thought inflation would pick up. Guess again.

The Consumer Price Index has advanced less than 2 percent in a year. Mortgage rates are still not far from historic lows. Low inflation is still with us even in this economic recovery and it may make the Federal Reserve reconsider its near-term timeline for normalizing monetary policy. 

 Interest rates on certificates of deposit? They are rising, but hardly as fast as savers would like.

  Right now, CD investors are paying an opportunity cost. Look at the recent performance of the S&P 500. Across the six months ending in June, the equity benchmark advanced 8.2 percent and it may end 2017 with a sizable double-digit gain.

  Now consider common CD yields, as surveyed by Bankrate. The average annual percentage yield on a 2-year CD was slightly above 1.5 percent in mid-July; 12-month inflation was running at 1.6 percent in June. Interest rates on 3-year CDs are currently topping out around 2.00 percent and the best rates on 5-year CDs are still under 2.5 percent. Conservative investors who feel uneasy about placing their money in stocks have little to celebrate given these low rates of return.

  Of course, CD investing is about more than the return. A CD investment can deliver liquidity, it can protect principal, it can add diversification to a portfolio and it can be a welcome refuge for assets if stocks enter a bear market. The Federal Deposit Insurance Corporation can insure as much as $250,000 of the value of a CD (the $250,000 insurance limit is per depositor, not per investment or account type).  In case of bank failure.

 The question is, what is a CD investor looking for today? Is he or she looking for downside protection? Principal protection? Liquidity? A CD investment is structured to offer all that in any stock market climate. Using a CD to invest for growth; however, looks like a highly questionable choice today. 

 Yes, there are fears that the stock market is at the top and awaiting a correction. True, some investors really hate risk. But are those two factors enough to make an investor settle for a 1.5-2.5 percentage return? Your answer to that question will depend on your preferred investment style, your risk tolerance and your financial objectives. 

If interest rates do rise steadily in the next 2-5   years, there are some CD investing choices that might result in more yield. Variable rate CDs may make sense, as their annual percentage yield can be adjusted upward in response to rising market rates. A laddered CD strategy could be promising – you divide the money you would invest in one CD among a few CDs with staggered maturity dates, so that you can replace maturing CDs with new ones at higher rates of return.

  You may want to park some invested assets in CDs and other savings instruments as part of a diversification approach. The inflation-adjusted return is currently minimal, but principal protection certainly has its appeal. (Note that surrender charges will apply if you attempt to liquidate a CD.) Any guarantees regarding safety of principal are based on the claims-paying ability of the issuing financial institution; brokered CDs may not be FDIC insured. Traditional CDs are FDIC insured and can offer a fixed rate of return if held to maturity. 

    Ken Weise, an LPL Financial Advisor, provided this article. He can be reached at 707-584-6690. Securities offered through LPL Financial. Member FINRA/SIPC. The opinions of this material are for information purposes only.