Return of the CD's (Part One)

 

Want to earn 9% on a certificate of deposit (CD)?  Find a time machine and let me take you back about 40 years.  I was working in Washington, D.C., at the time; we were just starting to save for our sons’ college education, and the bank up the street from my office had a 12-month CD paying 9% interest. 

Envious?  Don’t be.  The prime rate then had been hovering in the high teens, and of course took credit card and car loan interest rates along with it.   The interest rate on our FHA home loan was 11%, and we thought it was a bargain.

CD’s go in and out of favor over time.  In the (more distant) past (and perhaps again now) they were a reliable and safe source of regular income for retirees.  They are typically issued by banks and almost always insured by the Federal Deposit Insurance Corporation.  More recently, when the Federal Reserve was holding the prime rate near zero, CD’s were paying next to nothing in interest.  Same for bank accounts.  It was perhaps a year, or just a bit more, ago that the monthly “best bank and CD rates” feature in Kiplinger Personal Finance magazine highlighted “high interest bank accounts” and CD’s that were paying 1% interest.

How things have changed.  If you want an illustration of how decisions by the Federal Reserve Bank affect your everyday life, trace how their steadily increasing the prime rate correlates with the steady rise in bank account and CD rates (and car loan rates, mortgages, credit cards….but let’s keep this positive).  It’s possible to find money market accounts paying over 4%, CD’s paying over 5%, and more and more bank checking and savings accounts upping their meager interest rates to the highest they have been in 15 years.

Is now the time to jump in and buy CD’s?  The correct answer to any personal finance question is almost always, “It depends”.

If you are years away from actually needing the money you have to invest—whether it’s for a child’s education or your own retirement—the stock market still shines as the best long-term prospect for growing your stash; equities have consistently outpaced inflation over time.  Yes, there are dips in the stock market, but carefully investing (and that does NOT include chasing speculative ventures like cryptocurrencies) has proven a winning strategy over time.

But I can see a couple of groups of people for whom CD’s might make an ideal investment.  A sizable group of would-be investors sits on the sidelines of the stock market because they believe stocks are going to fall in value soon.  Short-term certificates of deposit paying stratospheric (by comparison to the recent past) interest rates is a good place to store cash while they await the expected stock crash.  This includes retirement accounts.  IRA and 401(k) account custodians (e.g. Vanguard, Schwab, Fidelity and even banks) can sell you CD’s within your retirement account.  No need to withdraw the money from the retirement account and suffer the accompanying tax hit.  And for those nearing the time when they must access that store of money (e.g. a parent with a junior in high school), this might be a good time to put the money into CD’s to keep it safe and readily accessible while still making a decent return, even if it’s not outpacing inflation at the moment.  For that matter, anyone needing safety for their money could do worse than investing in CD’s.

I fall into the first category.  Oh, I’ve still got the bulk of my savings in stocks and bonds, but I’ve got some cash sitting on the sidelines waiting to be used to purchase stocks when their prices go down.  The money market account where I hold the cash is now paying over 4% interest.  Nevertheless, I decided to tie up a portion of it in a CD ladder.  A ladder is just a method of purchasing timed investments such that their maturity dates are staggered.  I built a CD ladder where I had one-fourth of the invested money maturing every three months.  It earned me an average of about 5%.  There is nothing inherently risky about a ladder.  Retirees have used them for years to guarantee a stream of income.  It is the underlying investment that makes a ladder risky or not risky.  A ladder of bank-issued, FDIC-insured CD’s?  Pretty safe.  A ladder of cryptocurrency futures contracts? Not so much.

In my next post I will write about the pros and cons of buying certificates of deposit from a broker.

Until next time,

Roger

“Invest in seven ventures, yes, in eight; you do not know what disaster may come upon the land.”  Ecclesiastes 11:2 NIV*

*Scripture quotations taken from the Holy Bible, New International Version® NIV® Copyright © 1973,   1978, 1984, 2011 by Biblica, Inc.™  Used by permission.  All rights reserved worldwide.

Being Too Generous?

 

It is sometimes said that there are good and bad types of debt.  A mortgage on your primary residence might fit into the “good” category.  The home is a necessity, is typically too expensive for the borrower to pay for out-of-pocket, and may grow in value over time.  A personal loan taken out to finance a big birthday bash might qualify as a bad debt since it purchases only a short-lived experience (although I believe some rare experiences that offer a unique opportunity for personal happiness or fulfillment might be worth going into debt).

In the same way, there are good and bad ways to financially assist your adult children.  Helping them fund a college education is probably the most common form of financial aid.  But more and more parents are jeopardizing their own retirement security to help their older children in ways that might not be all that helpful in the long run.  According to a Merrill Lynch/Age Wave study cited recently by FaithFi, 82% of parents indicate they are willing to make a “major financial sacrifice” for their adult child. 

I get that.  I’d probably fall into that 82%.  But I’d like to think I’d be more discriminating in what I chose to finance for them.  A financial gift that promoted consumption over investment—say, a vacation?  I’d probably pass on it.  In fact, the authors of the book The Millionaire Next Door said that they found a direct negative correlation between parents providing money to their grown children and those children’s ability to build their own wealth.

Keeping your adult child on your health care insurance (even if it is allowed now by law), and every month paying for their cell phone, Netflix subscription, or even groceries neither builds their self-reliance nor even their self-esteem.

But the consequences for the elderly or soon-to-be elderly parents can also be dire.  According to the same Merrill Lynch study, 43% of parents are willing to live less comfortably, 26% are willing to take on debt, 25% would take money from their retirement account, 14% would refinance their house, and 8% would come out of retirement, in order to financially assist their adult children.

It can be a tough call to make if confronted with the choice of meeting a child’s need (not “want”) versus your own retirement security.  I’m not advocating a one-size-fits-all approach to this dilemma.  And perhaps there is some middle ground; a loan, for example.  But just remember, parents: No one is likely to be around to finance your retirement, particularly your needy child.  If you run out of money in your old age, a reverse mortgage might be your last option, assuming you own the home in which you live.  And taking out that type of loan usually guarantees none of your heirs will inherit that home.  The bank will get it. 

Think before you leap into helping your adult child financially.  My rule of thumb for loaning money should apply here, too:  Don’t loan [give] more money than you can afford to live without, now or later.

Until next time,

Roger

“Which of you, if your son asks for bread, will give him a stone?  Or if he asks for a fish, will give him a snake?  If you, then, though your are evil, know how to give good gifts to your children, how much more will your Father in heaven give good gifts to those who ask him!”   Mathew 7:9-11 NIV*

*Scripture quotations taken from the Holy Bible, New International Version® NIV® Copyright © 1973, 1978, 1984, 2011 by Biblica, Inc.™  Used by permission.  All rights reserved worldwide.