People generally think of CDs as investments for risk-averse retirees. Also, you can’t usually buy CDs inside your 401(k) or other workplace retirement plan. Despite this, CDs have some peculiarities that make them worth a look, even if you’re a long way from retirement. According to Certified Financial Planner Allan Roth (who did not invent the Roth IRA) you should also consider using CDs as a replacement for bonds in your retirement savings.
Why? Because CDs offer two features bonds don’t:
Higher interest. Right now you can buy a 5-year U.S. Treasury bond paying 0.92%. An equally safe FDIC-insured 5-year CD from Ally Bank pays 1.79%. A 7-year CD from PenFed Credit Union pays 2.75%, while the comparable Treasury bond pays 1.49%.
Less interest rate risk. When interest rates go up, bond prices go down. That’s not true of CDs, which don’t fluctuate in value. If rates go up, you can just break the CD, pay the penalty and buy a new CD—or a bond, if bond rates are superior in the future. Of course, if interest rates go down, CDs don’t go up in value, either.
We could also compare CDs to a broad-market bond index fund like the AGG ETF, which has a yield of 2.04% and duration of 4.3 years. That’s not terribly different from the rate on the Ally Bank CD and it introduces default risk. About a third of the bonds in the index fund are corporate bonds, which are riskier than U.S. government bonds.
So, you’re getting almost the same yield and have less default risk and far less interest-rate risk. Why should this situation persist? “There’s this inefficiency we can take advantage of that Goldman Sachs cannot,” Roth says.
For more information on using CDs as investments, click HERE.
If you’re a more of a hands-on investor and want to add some CDs to your portfolio, you can buy them for your traditional or Roth IRA at most banks and credit unions.