Note: This article was originally published on 04.04.06. Italicized additions are from 10.24.11
Who needs bonds?
Even as Ben Bernanke ended his first meeting as the new Federal Reserve Board
chairman, even as he attempted to make his tenure more transparent, even as
he suggested that the Fed is on the right track to keep the economy
growing, inflation in check and eventually solve the bond market conundrum,
investors were looking the other way. These were kinder gentler time in the pre-Great Recession land. You and I knows what lay ahead for the first time chairman and how the following statement is no longer true
Certificates of Deposit are back.
One of the unfortunate fallouts of a low interest rate environment, such
as the one Greenspan created to give the economy a new feeling of
irrational exuberance - his work with the equity markets still stings - by
creating a hot housing market, was to take the good old fashioned CD and
make it literally worthless. No one, with the exception of those who are
in this type of investment for capital protection, really cared. There was money to be made elsewhere. Ironic how when the housing market was bubbling over, certificates of deposit were getting almost nothing for parking your money. And now, after the crash and continuous after-shocks, that the same thing is occurring.
The stalwart investment for seniors, certificates of deposit offered less than one percent just four years ago. Now that has all changed. The steady rise in interest rates has refueled an interest in these financial tools. Now, these bastions of capital protection along with their FDIC insured status are paying investors over 5% for as little as twelve months.
Do you remember this?
Along with the rising rates on CDs, money market accounts are also
seeing some serious rate increases as well, some not experienced in five years or more. We all know that even as housing came apart, the market crumbled, bailouts littered the landscape and Lehman eventually fell, the money market account came under some troubled times as well. Although investors don't often boil their sentiment down into one thought, if there could be one it was the fact that even something as resolute as the money market fund might be not as good as once thought.
Most financial professionals worth their weight were warning 401(k) investors about these types of accounts. Money market accounts, the more flexible cousin of the CD, is often the default option in these types of tax-deferred accounts. The call was for more active management of your funds by using those contributions to grow wealth. Now that has changed. More than one CFP was calling for you to go to cash during the bumps that 2011 is (was) and this is where they wanted folks to put their money. Even if they were gaining nothing and missing the market upticks in the process.
When the 5% plateau was breeched, suddenly, those looking for a profitable, safe and FDIC insured location for their cash c saw the CD and the money market account as the place to not only leave money
for the short term, but to leave huge sums parked inside. If ever I worried about financial advisers, it is when they are following the herd and calling it doing the best for their clients. Really?
The conundrum that Greenspan worried about still exists. In the short
term, Treasuries of a maturity of a year or less still pay more than their
long term brethren. But these short-term notes are paying less than CD's.
Only question now is how long before foreign investors jump in? They did by borrowing from other countries and buying our safety nets.
You should remember though, the tax treatment of these types of investments will be better kept outside of your 401(k) plans. Because cash is usually locked up in a CD for a year, it is considered a long-term capital gain and is taxed at 15%. It is still a better idea to keep your money actively invested but now the money generated for parking your cash while you decide is much better.
This is an excellent time to begin to ladder your CD portfolio. This is often a good idea for any sort of bulk investment purchase. Often
used in bonds to take advantage of different market conditions, laddering allows you to buy different maturity dates. Laddering allows you have your CDs mature at different times giving you the opportunity to buy something else more favorable or roll your money back into another CD if the rates are right. In the near term, this is likely to stay the same but its fun to look back on then to see if it could help us with now.