CD investing: Safety trumps yield


Dear Dr. Don,
— Robert Rung-out

Dear Robert,
Laddering does stink at current rates. What tempers the smell is the ability to reinvest in the market in a systematic way over time as the rungs mature. If you buy a five-year CD, you take the risk that you are “long and wrong,” locking into a five-year investment in a rising-yield environment. That’s the crux of your question: “Is the maturity too long?” I can’t provide you with a definitive answer to that, but if you don’t go past that five-year maturity, meaning you’re not CD laddering, it’s unlikely that a series of short-term CD reinvestments out to that date will beat your five-year yield.


For CD investors, safety of principal typically trumps building wealth as an investment goal. They’re willing to earn a reduced yield for the knowledge that they can’t lose money in the investment. However, there’s another risk, and that’s purchasing-power risk. If the yield on your CD isn’t higher than the inflation rate, your deposit loses purchasing power over time.

There are investments that guarantee principal and inflation-indexed returns — Series I savings bonds and Treasury inflation-protected securities, or TIPS. Newly purchased Series I savings bonds just earn the inflation rate, annualized at 4.6 percent at the time of writing, but the Treasury limits the amount you can purchase to $5,000 in paper form and $5,000 electronically in a calendar year. Five-year TIPS were priced to yield the inflation rate less 0.84 percent at the time of writing, so that’s not the answer. TIPS with longer maturities offer a yield over and above the inflation rate, but there’s price risk if you have to sell before they mature. Also, the yield above the inflation component looks a little stingy and for most investors, they’re best held in tax-advantaged retirement accounts.



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