Where Should I Roll My CD Money Over To? – Money Mailbox

by David@MoneyNing.com · 7 comments

Are you sick of the low yields of CDs? I am. Many of you have CDs that are coming to maturity soon, and Doug is one of those people with this very dilemma. Where should he put his money? Where would you?

I have placed funds in a 10 month CD (21,500) @ 2.030% that is due 3/18/10 and another CD (15,000) @ 2.470% due in Nov, 2010.

Additionally, I transfer $200 a month to a Vanguard 500 Index fund – My question is where would you suggest I place the funds from the CD that is due next month? and how do you feel about my Vanguard strategy? You gave me good advice before and know by my questions that I am quite the novice. Many thanks in advance.

Let’s tackle the two questions separately. First, the one about your certificate of deposit (CD), and then the Vanguard strategy.

A Place for Safe Money

Compared to what you could get now, you’ve done well with the yields you are getting with your CDs. In order to figure out where to put your money from this point forward though, it’s absolutely critical that you understand what your money is being saved up for.

Ultra Short Term (Need the Money At Any Moment)

If it’s an emergency fund, then even a 10-month CD is not liquid enough. Think about this. In an emergency, you don’t have 10 months to wait on your CD to mature because you need your cash now. That’s why I suggest putting it in an online savings account because it offers the highest yield while still being FDIC insured. On top of that, you have immediate access to this cash whenever you need it. (In reality, it takes three business days, but the period is still short enough for most needs).

Medium Term (Need Cash in Less than Five Years)

If you need the money after a set time frame (say, you want to buy a house in 3 years, or go to college in 5 years for instance), then I would suggest looking into a longer term CD. Another alternative is to purchase I-Bonds from the government, which I will talk about below.

I-Bonds allow you to earn interest while protecting you from inflation. You may buy them via TreasuryDirect for a maximum of $5,000 and another $5,000 in paper issue through your local financial institution. The rate is determined by the base rate (which is fixed at the time you purchase them) and a variable inflation-adjusted rate. As of writing, the combined rate is 3.36%.

The caveat is that you must hold the bonds for at least twelve months, and redeeming the bond at any time before holding them for five years comes with a three month interest penalty. However, even with that penalty, many are finding that the return is still worth it. Furthermore, I-Bonds interests are exempt from state and local income taxes, and can be exempt from federal taxes too if you are using it to fund your education.

If you’d like explore the more traditional CD route, I can understand that the yield (or more appropriately, the absence of yield) can be frustrating. What’s worst is that I don’t think the yields are going to go back anytime soon. As I wrote about in How to find the best high yield savings account rates, the rate that a bank offers is just a function of supply and demand. Since the primary source of demand for your deposits is the bank lending it out to other entities, don’t expect demand to cause rates to rise anytime soon as banks are much less willing to hand money to others these days.

Another option, and one I would normally also recommend, is some type of a bond fund. However, with interest rates no where to go but up, bond funds are under a huge headwind. Buying individual bonds and holding them until maturity eliminates this risk, but it’s difficult to be diversified enough to make this worth while without a sizable amount to invest. Furthermore, investing in individual bonds require expertise that most people don’t have. That’s why, at least for now and as a whole, bond funds aren’t the way to go.

Investing for More than Five Years

Now onto more volatile investments, which you can gradually increase your exposure to the longer your investment horizon. This also covers your second question of your Vanguard S&P 500 strategy. I think it’s always great whenever someone has a plan to automatically invest periodically. Your pick of the S&P 500 index fund is a good one, but an alternative idea I really like is to invest in companies that provide dividends.

Vanguard has an index fund, the Vanguard Dividend Appreciation Index (symbol: VDAIX) that does just this. The fund tracks the Mergent Dividend Achievers Select index, which measures the stock performance of companies that have a record of increasing its dividends over time. Another ETF alternative is the SPDR S&P Dividend (symbol: SDY), which achieves a very similar goal.

I like a higher yield in my investments because I always reinvest my dividends, and when the market goes down, a higher yield actually forces more re-investments into the fund.

Of course, there are a ton more alternatives, but for now, check out these suggestions and we can share more as your portfolio grows.

Disclaimer: Obviously, these suggestions are based on my own personal opinion and should not be mistaken as financial advice you could receive from a financial professional. This is especially true, given that they can look at your particular situation in detail and provide a strategy that is custom tailored for your needs. Before you go ahead and invest in any of these, make sure you do your own research.

Note: Want your questions answered? Join others in submitting them by contacting me and we can talk about your money dilemma.

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{ read the comments below or add one }

  • Chris says:

    My vote for short term investments goes to an online savings account for sure. I agree that bonds will have some tough times ahead, if not the fact that there are record inflows into that investment class.

  • CD Rates Blog says:

    I’m a CD guy. Although I wouldn’t put long-term savings in a longer-term CD at this point unless:
    1) The CD has a low early withdrawal penalty.
    2) You have a good ladder already
    Rates will go up at some point and you don’t want to lock in low rates when we are about at the bottom.
    3) The CD has a bump-option. I’ve seen some 2Y and 3Y CDs with decent rates that have bump-options. That way when rates move up you can move the rate up on the CD.

    cd :O)

    • MoneyNing says:

      While I was writing this post, I thought about the concept of CD ladders, and couldn’t bring myself to write it down as a recommendation. It seemed like a good way to get money coming in, but why is the thought of having money coming every 3 months a good thing?

      I mean, if I’m retired and need income, then a periodic cash influx works like an paycheck, so this is good. However, for most people, isn’t the need for cash either now or some time in the unpredictable future? How does having money due once a year help? And if it doesn’t help, why am I giving up long term growth potential to invest in a CD ladder?

      Of course, CD ladders seem like a good solution for a small part of your portfolio, but for many, it’s MOST of their savings. This conservative approach may work for some instances in time, but it probably doesn’t in my honest opinion.

      What do you think?

      • CD Rates Blog says:

        The theory behind laddering is this: Rates go up and down and there is no way to time when, what direction, and for how long. Overall, long-term CDs pay higher than shorter-term. Our data shows a difference of between 0.50% to 0.70% between 1-year CDs and 5-year CDs.

        So if you build a 5-year ladder with 1-year increments, when the CDs mature you can always purchase 5-year CDs, knowing that first, your purchase at the time will be the highest rate. Second, once a year you will have an opportunity for higher rates. Of course, rates could be lower and in that case some of your existing CDs will be paying the higher rates.

        CD Laddering is really a method to smooth out the ups and downs of rate cycles, but certainly not have your entire portfolio re-price lower when rates do decrease.

        cd :O)

  • Mason says:

    I love the SDY. You can’t really beat higher dividends, lower volatility and better growth than the S&P 500.

  • marci says:

    CD’s CAN still be very liquid IF you borrow against them. I can borrow from the bank at 2% more than the interest the CD is giving me, use that cash for whatever, and then pay back the CD loan when the CD matures. That way I incur NO penalties for early withdrawal of the CD. Yes, the interest is higher, but it is shortterm and saves the penalty. You’d need to be absolutely sure that it was essential that you have the money, but it can be done.

    So don’t discount CD’s being somewhat Liquid 🙂

    And for an instant transfer of cash, a couple clicks or a phone call and 80% of the equity in my home is available thru my already set up (in case of emergency) home equity line of credit. It doesn’t get any quicker than that – and that is now my primary emergency fund so I can keep everything else in longer term bigger interest investments. Then when the investment matures, I’ll pay off the HELOC loan. It’s at 4.99% if I were to use it.

    • MoneyNing says:

      I will definitely look into a HELOC when I actually have a house. This way, I can be a little more aggressive with my emergency fund, as I can always tap into the equity of my house if in the unfortunate case that I need it.

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