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Are CDs Safe

Are CDs Safe?

Originally aired 7/21/2021

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What do CDs 💿(Compact Discs) and CDs 💰(Certificates of Deposit) have in common? They’re both a little outdated, but can they still get the job done? Join us for this episode of the Get Ready For The Future Show as we figure out if CD’s are safe methods of investing.

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SHOW NOTES

Video Killed the Radio Star

  • It took less than 10 years for compact discs to eclipse the sales of both vinyl albums and cassette tapes.
    • Today, with streaming services and music on our phones, CD players aren’t standard in every new car, and most stores no longer sell them.
  • This has left many music lovers with the question: What will I do with all my old CDs?
  • This is also a question many investors should ask themselves!
  • Personal Savings going up during the pandemic
    • April of 2020 the savings rate was at a record high of 33.7%
    • That’s over quadruple the savings rate in December of 2019
  • Unlike their musical counterparts, financial CDs—certificates of deposit—are still a popular short-term savings and income-generating tool since they’re low risk and FDIC insured up to $250,000.
    • A CD is a product offered by banks and credit unions that provides an interest rate premium in exchange for the customer agreeing to leave a lump-sum deposit untouched for a predetermined period of time.
      • CD rates are generally higher if you’re willing to sock your money away for longer periods.
    • Almost all consumer financial institutions offer them, although it’s up to each bank which CD terms it wants to offer, how much higher the rate will be compared to the bank’s savings and money market products, and what penalties it applies for early withdrawal.
  • They’re not susceptible to market swings, so their predictable nature has kept them in style.
  • But in exchange for their minimal risk, CDs offer low yields, especially in today’s historically low interest-rate environment.
    • Average National CD Rates:
      • 6 Month – 0.18%
      • 1 Year – 0.33%
      • 5 Year – 0.57%
      • (Source: Bloomberg as of 3/31/21)
    • Their so-called safety could actually introduce far more risk than investors anticipate, especially if the funds in maturing CDs are set to automatically roll over into another CD.
  • It’s all about time
    • Your time horizon is one of the most important things to consider when making any financial decision, but it’s especially relevant when it comes to CDs.
    • For short-term savers, CDs may be a good fit.
      • If you’ve saved money and know you’ll spend it in the next year or so, it could make sense to park it in a CD—where you can’t spend it on something else—and earn a little interest in the meantime.
    • But if you don’t think you’ll need to touch that money for even two years, you could actually lose purchasing power by saving with CDs.
      • Yes, you’ll get your principal back, plus the promised interest, you could invest differently to potentially earn more—even while drawing income.
    • Before the financial crisis, CDs and bonds paid stable, attractive income to investors.
      • But interest rates and bond yields have remained historically low for the last decade in the wake of the crisis, while the longest bull market on record for stocks ran from March 2009 to March 2020.
      • As long as this low-rate environment continues, finding income from CDs and bonds may continue to be challenging.
        • Meanwhile, dividend-paying stocks have provided both growth and the ability to create a rising income stream.
        • Alternative investments
          • Tax advantages
          • Opportunity for higher income

Ch-Ch-Ch-Ch-Changes (Turn and Face the Strange)

  • CDs offer a fixed rate of interest based on an agreed-upon investment period, and may have penalties for early withdrawals.
    • The income they generate is taxable annually (except in retirement accounts) and fluctuates with interest rates.
    • For example, the income on a $100,000 investment was only $590 in 2016 but rose to $1,290 in 2018. CDs are generally considered short-term investments and are insured by the FDIC up to $250,000.
  • Missed growth isn’t the only way CDs can cost long-term investors. They’re also susceptible to a double whammy of taxes and inflation.
    • In the ultra-low rate environment in response to the COVID-19 pandemic, banks can’t offer high interest rates to consumers.
    • Then, the interest earned from CDs is taxable, so Uncle Sam keeps a portion of that already measly return. And because CDs hold your money for a set length of time—often enforced with a penalty for early withdrawals—it means your investment may be helpless against inflation.
  • At the end of the day, it’s not how much an investment makes, but what you keep, that really matters. And when all is said and done, the real return from CDs has been negative for the last several years.
  • To sum it up, since they’re easy and convenient, CDs could still be a good short-term savings tool for you. But ask yourself what price you’re willing to pay for convenience.
  • Before you sign up for a new CD or automatically roll over an existing one, take a minute to step back and consider your time horizon and financial goals. Is this the most appropriate use of your money to reach those goals? Or would stocks, bonds, or a combination of both provide income while also growing your wealth for the long term?

I Ain’t As Good As I Once Was

  • In the month or two leading up to your CD’s maturity date, the bank or credit union will notify you of the impending end date. Its communication will also include instructions on how to tell them what to do with the maturing funds.
  • Typically, they will offer you three options:
    • Roll over the CD into a new CD at that bank. Generally it would be into a CD that most closely matches the term of your maturing CD. For example, if you have a 15-month certificate concluding, they would likely roll your balance into a new 1-year CD.
    • Transfer the funds into another account at that bank. Options include a savings, checking, or money market account.
    • Withdraw the proceeds. They can be transferred to an external bank account or mailed to you in a paper check.
  • In any case, the communication to you will stipulate a deadline for you to provide instructions, with an indication of what the institution will do in lieu of receiving your guidance. In many cases, its default move will be to roll your proceeds into a new certificate.
  • IMPORTANT: Missing the bank’s deadline for instructing it how to handle the proceeds of your maturing CD can lead to involuntarily locking yourself into a subpar rate for years to come, or incurring an unwanted—and potentially hefty—early withdrawal penalty because you waited too long before extracting your funds
  • There are other products out there that offer upside potential but bank-insured return of principal. We’re not making a recommendation, but it would be worthwhile to bring it up in a conversation with your advisor to figure out what’s right for you.
  • When you’re getting close to retirement, it could be easy to think you want to move your money into something low risk, or that you want to use excess cash to pay something off. That’s why you need a plan to consider your personal goals and dreams.

For the Times They Are A-Changin’

  • What’s the plan?
  • Ultimately, you shouldn’t bank your future on the performance of one product.
    • If your only plan is hoping you get a certain rate of return or that somehow it all works out, you don’t actually have a plan at all.
  • You need a plan that:
    • Protects against inflation
    • Maximizes Social Security
    • Secures guaranteed lifetime income
    • Considers a hybrid retirement
    • Plans for long-term care
    • Defends against taxes
    • Is written on paper, on purpose
      • A product alone can’t do this for you! It requires a comprehensive plan.
    • Your plan should be built for
      • Your financial goals are different than the next person who walks through our door. So, that means your financial plan will be, too.

FINAL THOUGHTS

    • CDs could be a viable option for some, but there may be other products out there that could give you better results.
    • Just like music on a CD has become outdated, financial CDs have as well!