Tons of people out there question the logic of purchasing 10-year CDs. And it is smart to question. Let’s consider a few historical data and pose some reasons for and against. You can then make up your own mind.
The first reason for considering a 10-year CD is the quest for a stable, decent yield. What is a good return? Since 1992, the 15-year average rate on 3-month T-Bills has been 3.86%. For 6-months, it has been 3.97%. For 3-month 2nd Market CDs it was 4.24% and for 6-months it was 4.34%. You can view this data and more at www.mortgage-x.com. You’ll need to cut and paste the link. Our database goes back to 1993. The average 6-month rate as of 6/30/09 was 4.448%. The average 5-year was 5.588%. So past data would imply that a CD rate above 4.50% would be decent and stable. Another thing to consider is the Early Withdrawal Penalty (EWP). IF the EWP is 6-months or less, it won’t be to expensive to close the CD and move the funds elsewhere if interest rates rise much.
Another reason may be that you want a well balanced and laddered portfolio. Not having all of your eggs in one basket is a good sign. What the various baskets are, is based on your risk tolerance, goals, age, etc. When it comes to diversified portfolios, if you have money maturing in the next 1-year, 2-year, 3-year, etc. you are well protected on that front. If yields go up, you can take advantage of those as your funds become available. If CD rates fall or hold, you have some money on the longer end that are protected with a nice rate. However, it is very difficult to try to have perfect timing. Historical information is just good as a resource; it provides no guarantees of what will happen in the future.
A very good reason for not investing in a 10-year CD is if it is the only money you have. Putting all of your deposits in any one investment vehicle isn’t a good idea. So if $100,000 is all you have, putting it in a 10-year CD wouldn’t be advisable. If you are in your later years, and principal preservation is your goal, taking that $100,000 and putting some in savings to cover emergency needs and then ladder the rest would be a good plan.
Another great reason against the idea is if you’ll be buying a house, sending children to college, etc. When is the big question here. If you plan on having any large expenses in the next 10-years, and you don’t have a very high reasonable expectation of having other means to cover them, don’t do a 10-year CD. Most longer-term CDs have a large penalty to close early and you don’t want to be in a situation where you have to break the CD. But, try to strategize (on the conservative side) when you will need the funds. Then ladder your funds out across different maturities. When each maturity comes up, reassess to see if you can still use the maximum term you have set-up.
For instance, you set-up a ladder that has certificates coming due every 6-months and the longest maturity is in two years. When the first CDs become available, determine when you will need them. If the funds will be needed in the very near future, move them to a high yielding savings accout, if not invest in the term that fits your situation, eg., a 1-year, 2-year or even longer term CD.
Here are some more resources for CD rates and historic rates.
For handy know how about bank cd rates - dig into hyperlinked publication.
RSS FEED