In a world where pensions have fallen by the way side, many people are looking towards Fixed Annuities. The problem is that these annuities are getting harder to find access to. Many Financial Advisors focus strictly on assets under management. Whereas many insurance professionals favor more complex, market-linked products. Neither are a bad option, but what if you want something cut and dry and short term commitment?? CDs? But they are paying anything? Municipal Bonds? Perhaps, but those still have risk and no guarantee. Maybe a bond heavy mutual fund? Yea, but then you are still running into market risk, when the market is performing, bonds funds generally are not.
What if you could just park your money with a 2 year commitment , no risk?!? Sound appealing? Thought so.
Well, we have a new product that few people have access to. You park at minimum $5,000 into this 2 year deal, you earn 3.2% plain and simple. This is as cut and dry as it gets
Times have changed as CD rates have continued to come down over the years. Rates have inched up about 0.5% since Trump’s presidential victory on expectations of higher growth and inflation. However, rates continue to remain depressed and will likely stay low for a long time due to economic slack, productivity growth, and technology.
When you have the 10-year treasury bond providing a ~3% return, your hurdle rate is very low. There is a good chance a monkey can randomly choose 10 stocks to build a portfolio that will beat these returns if history is any guide. The dividend yield of the S&P500 alone is around 2.6% for goodness sake. The 10-year bond yield is the hurdle you need to beat to make an investment worthwhile. Otherwise, why bother taking any risk when you can earn ~3% a year risk-free.
My conservative investment target return has always been around 2-3X the risk free rate of return. With the 10 year treasury yield likely staying below 3% for a very long time, I’m shooting for a 4% – 7% annual return (2-3X the 10-year bond yield). The problem is, no CD provides even close to a 4% return. As a result, we need to move up the risk curve.
I’ve got a $330,000, 7-year CD earning 4% coming due in 2018, which I plan to reinvest to earn at least a 4% rate of return. I do not plan to renew the CD into another 7-year CD at a 2.4% rate for another 7 years due to the current economic environment. Here are the reasons why:
* Highest rate available is a 10-year CD at 2.5% yield. (WHY the heck would you do this when I just said I can get you 3.2% FOR 2 YEARS!)
* CDs yields barely keep up with inflation. (3.2% for 2 years, Social Security Inflation rate is 2.8%)
* Locking up money for 10 years for 2.5% does not sound appealing, especially with an early withdrawal penalty.
* If there is significant 3-5% inflation due to so much monetary easing, CD rates will rise, making it foolish to lock up money at lower rates.
* The S&P 500 dividend yield is around 2.3%, and if Trump cuts corporate taxes and boosts government spending, there’s a decent chance this bull market in stocks may continue.
* Chances are decent investors should be able to outperform a 2.5% return in many other asset classes.
With CD rates so low and alternative investments relatively more attractive, it’s hard to argue a strong case for investing in CDs anymore. Perhaps if you are super risk adverse, already in retirement, and have no other passive income whatsoever, CD investing is appropriate. However even then, a 70 year old can find greater returns in often criticized annuities.