CDs Remain Useful Despite Low Yields

Many investors, probably most, start as a child with a simple bank account. Later come stocks, bonds and funds, with bank accounts mainly used for everyday expenses. They’re safe and convenient but don’t pay much.

A top-yielding certificate of deposit might pay a bit more than 2 percent if you’re willing to tie your money up for five years, for example, while the Dow Jones industrial average is up more than 18 percent since the start of the year.

Why, then, would anyone buy a CD?

There may be several good reasons, experts say, mainly because of safety. That’s especially so at a time like now when other interest-paying investments, like bonds, are in danger of losing value from rising interest rates.

[See: 7 of the Best Stocks to Buy for 2018.]

“Yes, there is a case for CDs today,” says Chris Robbins, investment advisor and fixed-income analyst for Bartlett & Co. in Cincinnati.

“CDs can be a good fit for risk-averse investors with a specific future cash need, or those trying to create some income stability within a larger portfolio of other assets,” Robbins says. “But investing in CDs won’t give you the same yield as something that carries more risk, like corporate bonds. So there’s a tradeoff.”

CDs are meant to be the generous option in bank savings. Because investors must lock their money up, typically for three months to 10 years, banks will pay more on CDs than in savings accounts, money-market accounts or interest-bearing checking accounts that allow withdrawals at any time. Cash stashed in CDs is available for the bank to put to work in mortgages or other loans.

The longer you’re willing to tie up your money, the more you’ll earn.

An average one-month CD will yield about 0.2 percent these days, while you can get nearly 1 percent on a two-year deal or about 1.5 percent five years, with better deals available if you’re willing to go to the most generous providers wherever they are. That’s better than next to nothing earned on a savings or checking account, but won’t make you rich. In fact, a shorter-term CD will lose money when inflation is considered.

On the other hand, making a killing isn’t always the chief goal. Many investors want safety, at least for a portion of their holdings, and CD holdings up to $250,000 per person are insured against loss by the Federal Deposit Insurance Corp. Making 1 or 2 percent would seem like a killing if your stocks tumbled 20, 30 or 40 percent.

So a CD is a good place for cash you want to keep safe but don’t need for day-to-day expenses. A portion of the rainy-day fund could go into a CD so long as you had ready cash in savings or checking for the first few months of an emergency.

Today, many CDs with maturities of less than three years are more generous than U.S. Treasury bonds, or other U.S. agency bonds with similar maturities, Robbins says.

Fixed-income investors might find CDs particularly attractive today because, unlike most government and corporate bonds, CDs do not lose value when interest rates rise, says Ken Tumin, founder of DepositAccounts.com. Bonds lose value when rates rise because investors don’t want older bonds that pay less than new ones. CDs pay the yield promised no matter what happens to rates in the meantime.

[See: 11 of the Best Fixed-Income Funds to Buy.]

People investing for the long term typically have an assortment of holdings ranging from risky stocks to safer bonds. Cash in a bank is the safest holding for a long-term investor. It will help stabilize the portfolio, damping the ups and downs from other assets.

“Even long-term investors can benefit from CDs,” Tumin says. “If you plan to have some of your portfolio in bonds, additional safety can be gained by replacing some of those bonds, bond funds and/or money-market funds with CDs.”

And bank savings can be useful for “dry powder” — money you are keeping handy for investment opportunities, or for a known need for a specific time, like college tuition, that allows cash to be tied up for higher yield but will come soon enough to require safety.

“If you know you’ll need a certain sum of money in a period of three to four years, investing that sum into a CD provides a high degree of confidence the money will be there when it is needed,” Robbins says.

A savvy investor might buy a series of CDs, using shorter maturities for cash that might be needed on short notice, and longer maturities for cash meant to stabilize a portfolio and still be accessible fairly quickly. This is called laddering.

“A simple strategy is investing 20 percent of the available funds to CDs maturing in one, two, three, four and five years — five tranches,” says James F. Lubin, CEO of Beacon Hill Private Wealth Management in Woodbury, New York. “This approach enables our clients to earn a marginal rate of return yet provide for the reinvestment of maturing CDs at the current — potentially higher — rate of interest.”

With CDs of a year or longer it would make sense to look at terms on early withdrawals in case an emergency or great investing opportunity does come up. In many cases, the penalty for early withdrawal is loss of the most recent six months’ interest earnings, and the bank may dig into your principal if you haven’t had the CD that long. With yields as low as they are, that’s not an awful sacrifice if the need or opportunity is strong enough.

“Many CDs have reasonable early withdrawal penalties that can minimize the risk of missing out on new CDs with rates that have risen to much higher levels,” Tumin says.

As mentioned, it may be important to be able to tap your CD on short notice. So it could make sense to get one with the bank that already has your checking and savings accounts, allowing CD proceeds to be automatically swept into an account that’s easy to use. Given today’s low yields, it may not be worth the inconvenience to buy a CD from another institution just to earn a few more dollars a year.

[See: 7 ETFs That Let You Invest With the ‘Smart Money’.]

Still, it does make sense to shop around, Robbins says. With the internet, that’s easy. If you choose a bank you don’t already deal with you’ll probably be able to purchase your new CD online with a simple cash transfer, and getting money from redemptions in just a few days.

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CDs Remain Useful Despite Low Yields originally appeared on usnews.com

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