Friday, August 6, 2010

Don't Discount CDs For Savings

Tip #268 - Don't Discount CDs For Savings. Yes, CDs (Certificates of Deposits, not the music kind) currently have ridiculously low rates, I know. But they can still be part of your savings plans. Many of us in this low-interest market want the kind of returns that only stocks and high-risk investments can possibly return. But remember that those high-risk investments with potential for high returns also can have negative returns. So that stock that you were hoping would acheive a 10 percent return for the year can return a negative 3 percent instead. While a CD can return a positive 3 percent. That's a difference of 6 percentage points.

CDs certainly aren't for every person for every savings goal in every season or for ones whole portfolio. But they do have a place in most people's portfolios for many goals. For example, if you are saving for retirement, and are 30 years old, most financial experts would tell you to put a majority of your investing into stock mutual funds or something similar since retirement is so far off. Some might follow the old rule of thumb of subtracting your age from 100 and putting that percentage in stock mutual funds (70% in this case). They may advise to put a smaller percentage in bonds (maybe 20%) and a still smaller percentage in cash or guaranteed investments (maybe 10%). Well, why not look into CDs for those guaranteed investments? My credit union is paying about 3% for a 5-year CD these days. It's not much, to be sure, but it does add some nice balance to a portfolio.

Of course you don't need to follow anyone's rule of thumb with regards to investing. You need to do what is comfortable for you. I know people who like to take on a lot of risk and put nearly all of their money for their retirement into stock mutual funds. I also know some people who are quite conservative who tend to hold more a higher percentage of CDs and government bonds than are recommended.

CDs are a good place to start out with your investments because you will earn greater returns than a savings account or money market account. You will be tying up your money for a certain amount of time, though, which is why you get the greater return. CDs are guaranteed by the FDIC so you cannot lose any money if the bank goes under. If you belong to a Credit Union, that is a great place to start with CD savings since they tend to be more flexible with penalities for withdrawing early on a CD. And if you don't belong to a credit union, you should consider joining one.

CD's might also have a place in your college fund portfolio. While many people in the past few years socked money away in their 529 plans that lost money, the 5-year CDs had rates of 4% and 5%. Doesn't sound so bad, does it? Better than the negative returns many experienced but not as good as the 10% or 12% than many hoped would be the case. Remember college savings isn't all that long of a time frame (18 years at most). And if the rates are in negative territory, there is not too much time for them to recover before your son or daughter goes off to school.

Just because CDs aren't a high-risk, high-return investment, doesn't mean that it's not right for you. Low risk, low return investments have their place in many people's portfolios, too. And while they are not as hip, cool, or sexy as stocks and mutual funds, they are sometimes a better choice.

Consider what you are saving for, how long you have to save for your investment, how much risk you are willing to undertake, and what other investments you have in your portfolio to see if there's a place for CDs among your investments.

In Real Life (IRL) - I really like CDs. I have some knowledge about stocks. I have some knowledge about mutual funds, and I am not scared or inexperienced in investing in either one of those. And during the early 1990's some stocks and mutual funds were my best friends, giving me great returns. But I never let go of the "guaranteed" CDs. Sure they were returning 5% when stocks were giving me 12%, 15% or even 20%. But they gave me some sense of stability and added balance to my portfolio.

When we started saving for college, I put a fair percentage in CDs. They were returning over 5% when I started these 5- and 7-year CDs. With only an 18 year time-frame from the first time I invested for my daughter's college to a much shorter time-frame now (only 10 years away), CDs actually seem like a good choice to me for that short time period. About 75% of our daughter's portfolio is earning 4%-5% for college. And while I know full well that I'd be singing a different tune if the stock market were soaring now rather than declining, I am still happy earning a lesser percentage in return for peace of mind.

Our retirement portfolio also has a higher-than-suggested-by-the-experts proportion in CDs. We have about 40% of our retirement in CDs and similar guaranteed investments even though our retirement is still 20 years away. It's a percentage I feel comfortable with at this stage in our lives and with the state of the economy. And yes, I know inflation can sometimes outpace CD returns, but stocks can have bad years so I pick what I consider the lesser of two risks for the time frame I am investing for. Others may choose differently.

Another reason I like CDs is because we found out we are able to "back invest" in our education and retirement CDs at our Credit Union (Navy Federal Credit Union) during a grace period, which we can invest in CDs that we already have open. This is a great option since we have some CDs with a few years left on them that are paying over 5%! (This is why I love credit unions!) It's a deal we only found out about last year, but we have been able to add to both our retirement account and education accounts this past year, and plan to do so while we still have these good rates.

So consider CDs carefully. They can be a valuable tool in many investment portfolios. For other ideas on how to spend less money or save some up, check out Frugal Fridays.

***Please note that I am not a financial advisor nor a financial planner. I am just one person who is interested in saving and investing money. My thoughts are my opinions only. You should seek qualified investment advice from a professional before you invest.

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