Bank CD’s, in general, have never been glamorous. They are simple “time deposits” which carry a small interest rate whose principal and accrued interest are federally insured by the United States government. While moving congruently with mortgage rates, bank CD’s are currently at historic lows. The yields provided on even the longest term CDs are still struggling to keep up with the rate of inflation and may end up providing no ‘real return’ to the investor upon maturity.
So why keep these lousy products in your portfolio?
Well, regardless of the abysmal rates, the products are still a safe haven storage for cash. And while younger people just entering the workforce and beginning to plan for retirement may not need these products currently, they will likely want them in the future. And for the older population whom may be considering retirement in the near future, these are still corner stone investments for cash class assets.
Most financial advisers recommend choosing a more risk-adverse path towards retirement as an individual ages. And therefore, may not necessarily recommend bank deposits to those who are fresh out of school and beginning to enter the workforce. However, those portfolios that have already had decades of growth under their belts, can look to protect the returns already garnered through federally insured investment vehicles which don’t expose the principal to any risk. This isn’t too say bank CDs (even in a positive interest rate climate) should ever make up a majority of overall assets, but they should hold a generous portion of the asset section allocated to cash.
If you’re just starting to add certificates of deposit to your portfolio, you may want to implement them through a ‘CD ladder.’ CD ladders allow you to take advantage of higher yields from long term CDs while still providing regular cash flow. The way in which you implement a CD ladder is by distributing the money you have allocated for bank deposits over a period of 5 years – with the goal of locking in the highest rate possible through the longest term available. So for example if you have $50,000 designated for deposits. You would invest $5,000 every 6 months (for a total of 5 years) into a new 5 year term deposit. After 5 years your first deposit would mature and would lead to a chain of maturities following every 6 months. This way you can benefit from the longest-term rates while retaining the option to re-invest or withdraw the money in shorter-term intervals.
Despite the fact that interest rates are terrible, cash in our portfolios still needs a place to grow while idle. And rather than having it simply sit in a non-interest bearing fund, depreciating at the rate of inflation, one should consider these savings vehicles as an alternative (however lackluster they may seem).
This article was written by Dan Nelson – the owner and primary contributor to BankVibe.com. BankVibe was founded in 2008 and covers bank rates, deals and industry news.
Photo by milos milosevic