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So why not just put it all in CDs?

So why not just put it all in CDs?

July 06, 2023

So...why not just put it all in CDs? 

It is great to see higher interest rates come back in many ways.  OK, it is tougher to buy a house or car, but if you are more of a saver than a spender, the higher rates available on cash savings right now are a relief. 

When you can essentially put money into a government insured product yielding over 5% however, some more conservative investors will start to wonder “Well why not put all my savings into CDs and eliminate all risk from my portfolio?” 

It does sound appealing.  Perhaps a blended portfolio of 60% stocks and 40% bonds can expect to earn 7% per year on average – but that investment entails significant risk.  Investors in such portfolios have experienced a nice recovery this year – but 2022 was brutal with the average moderate risk portfolio probably losing close to 20% of its value.  A 5% guaranteed return might seem appealing in comparison. 

While short term bonds and CDs certainly have increased appeal today, there are several reasons why putting your entire portfolio in these instruments doesn’t make sense.  And as usual with investment strategies, it involves shifting your perspective from the short term to the long term.  Here are the problems with going “all cash”: 

  • These rates won’t last forever. It is an unusual curiosity that a 2-year CD pays a higher interest rate than a 10-year US Treasury bond.  Both are risk free if held to maturity – why wouldn’t you earn more interest to tie up your money for 10 years?  The reason is that the market does not expect these high rates to last.  In 2 years when that CD matures, you may find rates are back down to 1 or 2%.  You would then be faced with the alternative of either accepting much lower returns or being forced to invest in stocks (regardless of the market environment at that time).  The investor who locked in rates by purchasing a 10-year bond at 3.8% may not make as much money in interest today, but he knows he will be enjoying that rate for a long time to come. 
  • Short term rates rarely keep pace with inflation. Sure 5% sounds great compared to the sub 1% rates of a few years ago – but inflation is higher as well.  Over the long run, rates on short term bonds and CDs rarely keep up with inflation.  Investors generally expect to earn a negative inflation adjusted rate of return.  Stock returns on the other hand, have tended to outpace inflation over long periods of time, as companies can raise prices (and profits) to keep the effects of inflation at bay.  It is important to include stocks in a portfolio as part of an inflation beating investment strategy.
  • No opportunity for capital gains. If interest rates fall, longer term bonds (like that 3.8% Treasury bond) will increase in value.   A bond investor has an opportunity to realize capital gains on his bond holdings, as well as collecting interest payments, if interest rates fall.  Generally, the longer term the investment is, the more the investor can realize in gains from falling rates.  CDs are designed to be held to maturity, so the owner can’t effectively realize capital gains if interest rates fall.  

I like holding some cash and CDs at these higher rates – but it should be just a part of an overall asset allocation strategy.  Putting money you expect to spend over the next 2, 3, or even 5 years into money markets or a ladder of 12 to 36 month CDs makes sense.  It is reasonable to include up to 10-15% of your portfolio (if you are a conservative investor) in these instruments, with the rest in stock and bond funds.  Such an allocation will help protect against a 2022-like situation where both stocks and bonds fall in value, while providing a nice boost to your portfolio’s dividend income.