Is it Time to Replace Your Bonds With CDs?

Last week, US stocks briefly reached a record high and 10-year government bonds (U.S. Treasuries) briefly dipped below 2%. That yield is close to the historical low of 1.35% reached in 2016. If you are approaching retirement, what are you to do? Stocks are near all-time highs, but government bonds are only paying you approximately 2%. Keep in mind that 2% is gross of any fund or advisor fees. One thing to consider is optimizing your fixed income.

Over the last 10 years, most people referenced bonds when discussing fixed income. That's because cash and CDs weren't paying much. Over the last 18 months, things have changed. Bond interest rates have come down while cash and CD rates have gone up.

Government Bonds vs. CDs

Many investors use government bonds for a large portion of their bond investments. These are considered safe because they are backed by the full faith and credit of the U.S. Government. Due to their low risk nature, government bonds typically pay the least interest. Below, I compare government bond interest rates with CD interest rates of the same maturity. These interest rates are as of 6/21/2019.

Government Bonds CDs

1 year – 1.95% 1 year – 2.71% - Sallie Mae

5 year – 1.80% 5 year – 2.81% - American Express and Discover

10 year – 2.07% 10 year – 3% - Discover

Via FDIC insurance, the CDs are backed by the full faith and credit of the U.S. government up to FDIC limits. This makes their credit risk the same as government bonds. The big question is, “What will happen to interest rates?” If interest rates decrease, bonds could perform better than their current stated interest rate. But if interest rates stay the same or go up, the CDs should outperform.

Future Interest Rates

So, what will interest rates do over the next 12 months? Honestly, I don’t know. You should be skeptical of anyone that has a prediction.

According to the Wall Street Journal, at the beginning of 2019, no economists predicted the 10-year U.S. Treasury yield would be where it is today. At that time, the average estimate for the 10- year Treasury yield for June 2019 was 2.96%. As I noted earlier, it is almost a full percentage point less.

It’s very difficult to predict interest rate movements. The good news is you don’t have to. When it comes to interest rates, what you see is what you get. You can’t base your decision on past interest rate movements, and you can’t predict the future. Ultimately, you need to focus on the interest rates today when comparing fixed income options.

What Does This Mean for You?

I don’t think investors should abandon U.S. Treasuries, but I do think they should give cash and CDs a second look. Opportunities to reduce risk and increase return are few and far between. When you see them, you should try to capitalize on them.

Keep in mind that optimizing your fixed income is only one piece of your financial puzzle. You should also figure out if you have enough in fixed income to begin with. One way to achieve that is to have enough cash and bonds in your portfolio to fund the next 10 years of withdrawals. As a recent Barron’s article mentioned, the next 10 years of market returns probably won’t look like the last 10 years of returns. If you are about to enter retirement, you should make sure you have enough in fixed income first. After that is in place, you can attempt to optimize your fixed income investments.

As a fee only financial planner, I help clients get into the weeds of optimizing their investments as well as look at the bigger picture. If you would like some help getting pointed in the right direction, feel free to set up a quick 15-minute phone call here.