Why Would You Want CDs in Your Portfolio?

CDs in Your Portfolio

Would you ever want CDs in your retirement portfolio?

This question has been coming up ever more frequently these days since Bernanke's announcement this month, which all but guaranteed record low interest rates remaining throughout 2013. The answer to this question, however, varies depending on individual circumstance.

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

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  1. There are actually a lot of reasons for a person to have at least some CDs in their portfolio even if they aren’t close to retirement:

    1) It’s a safe place to “keep your powder dry” for the next opportunities in stocks–the ladder idea works well with this since certificates come due regularly

    2) Having at least some money in fixed income investments lowers downside risk when stocks fall

    3) If stocks go into a protracted fall, like 2000-2002, the “low rates” on CDs won’t look nearly so low. Not losing money in down markets is as important as making it in rising markets.

    We should never dismiss CDs out of hand. Rate or return isn’t and never was their entire purpose for being in a portfolio.

  2. Barb Friedberg says:

    Although now the returns are awful, the interest rates will eventually rise. But, for now, most everyone needs a bit of cash, so you mightr as well stick your cash allocation in a cd.

  3. Every time I see my retired Aunt she tells me about the horrible rates she’s getting on her CD’s. I can remember years ago when I was helping her with her Schwab account where she was actually getting 4 percent or greater. Now she’s lucky to even get 2%. She refuses to put the money anywhere else though, so as the first commenter mentioned, she’s basically losing money (with inflation etc) and not realizing it.

    I guess I just hope we’ll see higher rates when I get closer to retirement. There just aren’t a ton of options out there for fixed income. I’ll likely do some heavy dividend stock investing as part of my strategy.

  4. Paula @ AffordAnything.org says:

    I agree with Funancials — traditional CDs come in lower than inflation. If you want a safe bet, go with TIPS.

  5. Funancials says:

    Traditional CDs don’t make sense for anyone right now. Given the current rates, savings accounts (with no withdrawal restrictions) are paying more interest than CDs.
    I often get a good laugh from CDs. The people who invest in them are so afraid they will lose money. Ironically that’s exactly what they are doing by investing in CDs right now. After taxes and inflation the real return on CDs is decreasing and that investor is losing purchasing power.

  6. CD ladders or even money market accounts are usually where I prefer to keep some cash to have on hand. We generally use them for two reasons which are our 8 months emergency fund and also our regular savings to have cash on hand. Never used the CD ladder approach something to look into.