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Fixed income: Bonds versus CDs
Posted on 2/5/24 at 1:23 pm
Posted on 2/5/24 at 1:23 pm
Approaching retirement age, I am gradually shifting from equities to fixed income which (hopefully) can generate a return beating inflation.
Looking at good quality bonds (not bond fund but the bonds themselves) and CDs.
Both are paying 4.5 to 5 percent. But, while the bonds I am looking at (Walmart, Microsoft, Apple, etc.) are very unlikely to default in the near term the CDs come with FDIC protection.
So, why would anyone buy bonds? Am I missing something?
Looking at good quality bonds (not bond fund but the bonds themselves) and CDs.
Both are paying 4.5 to 5 percent. But, while the bonds I am looking at (Walmart, Microsoft, Apple, etc.) are very unlikely to default in the near term the CDs come with FDIC protection.
So, why would anyone buy bonds? Am I missing something?
6
Posted on 2/5/24 at 1:34 pm to Roscoe14
quote:Bonds in theory at least have daily liquidity (although even for the blue chip names you mention, it's not great).
o, why would anyone buy bonds? Am I missing something?
My question is: why would anyone do CDs when there are so many better, more liquid options?
Posted on 2/5/24 at 1:37 pm to Big Scrub TX
quote:
My question is: why would anyone do CDs when there are so many better, more liquid options?
Thanks, BST. It is a retirement account so I am not that worried about liquidity. But if there are better options than CDs I would certainly like to hear about them.
Posted on 2/5/24 at 1:37 pm to Roscoe14
Opportunity cost. Those CD rates will not last beyond a year.
Posted on 2/5/24 at 1:48 pm to Shepherd88
quote:
Opportunity cost. Those CD rates will not last beyond a year.
I can see from the rates on 2-5 year CDs that this is likely the case. Are rates from bonds historically more stable?
Posted on 2/5/24 at 2:00 pm to Roscoe14
quote:
So, why would anyone buy bonds? Am I missing something?
Even if you’re comparing apples to apples (same coupon rate and same term), large institutions can’t effectively buy CDs, so AA or higher bonds become more attractive to them due to the scalability.
However, that’s mostly irrelevant to an individual retail investor. Just answering why “anyone” would buy them.
What kind of terms are you considering?
Posted on 2/5/24 at 2:14 pm to slackster
quote:
What kind of terms are you considering?
For example, a 12 month Morgan Chase CD at 5.2% versus a 12 month Microsoft bond with a YTM of 4.795.
Posted on 2/5/24 at 3:25 pm to Roscoe14
quote:Here's a running thread I have about a superior cash option presently:
But if there are better options than CDs I would certainly like to hear about them.
LINK
Basically, a treasury ETF which covers a very specific part of the government bond market. It's perfect for our present condition of the front end of the curve being so high.
Right now, I also like this:
JAAA
It's a Janus ETF covering a very specific part of the AAA corporate market. It's paying north of 6% now with a YTM closer to 7%.
But even more basic than that, I'd rather be in a money market than a CD. I just can't see giving a bank a hold on my money for basically nothing in return.
ETA: And if I did want to do actual bonds, I'd probably steer toward munis - the muni curve almost always trades cheaper than where it should compared to taxable.
This post was edited on 2/5/24 at 3:27 pm
Posted on 2/5/24 at 4:03 pm to Big Scrub TX
Great advice, thanks.
Posted on 2/5/24 at 4:15 pm to Roscoe14
quote:
Great advice, thanks.
Posted on 2/5/24 at 4:52 pm to Big Scrub TX
I like muni bonds.
As for bank CDs, I don't quite see the liquidity problem.
Maybe I'm not experienced enough with all of the CD options.
But in the past, early forfeiture of a CD penalizes you 3 months interest.
Does the fact that there is a penalty at all suck? Sure.
But calculate out what 3 months interest is and let me know how much that will sting based on needing to break the contract. My guess is that it would feel like pennies.
As for bank CDs, I don't quite see the liquidity problem.
Maybe I'm not experienced enough with all of the CD options.
But in the past, early forfeiture of a CD penalizes you 3 months interest.
Does the fact that there is a penalty at all suck? Sure.
But calculate out what 3 months interest is and let me know how much that will sting based on needing to break the contract. My guess is that it would feel like pennies.
Posted on 2/5/24 at 4:56 pm to meansonny
quote:It's highly specific per CD.
But in the past, early forfeiture of a CD penalizes you 3 months interest.
quote:I mean, you could kind of say the same thing about the interest to begin with. How much more is a CD really offering you over other options (if anything at all)?
But calculate out what 3 months interest is and let me know how much that will sting based on needing to break the contract. My guess is that it would feel like pennies.
Posted on 2/5/24 at 4:58 pm to meansonny
quote:
As for bank CDs, I don't quite see the liquidity problem. Maybe I'm not experienced enough with all of the CD options. But in the past, early forfeiture of a CD penalizes you 3 months interest.
Brokered CDs typically don’t have any penalty. They’re just sold at the market value less any transaction costs.
Posted on 2/5/24 at 5:03 pm to slackster
quote:And what sort of premium do they typically garner?
Brokered CDs typically don’t have any penalty. They’re just sold at the market value less any transaction costs.
Posted on 2/5/24 at 5:11 pm to Roscoe14
quote:
Approaching retirement age, I am gradually shifting from equities to fixed income which (hopefully) can generate a return beating inflation.
You don’t have to have bonds just because you’re close to retirement. Bonds should be in a portfolio to help with stability and income generation - mainly - but other income plans can take pressure off the portfolio and eliminate the need for significant bond holdings (maybe even completely eliminating them).
I’ll use the ETF SCHD as an example. $1,000,000 of SCHD in 2014 would have generated approximately $27,000 in dividends. Today you’d be getting over $68,000 in dividends and have approximately $2,000,000. You would have received annualized raises of around 4.9% since 2014 too.
I realized 2.7% doesn’t seem like a ton of yield, but with a large enough portfolio it could be more than enough.
People like to say if they won the lottery they’d buy muni bonds and just collect the tax free income, but that sounds abysmal to me. Give me something like SCHD or even a broad market ETF where I’d have rising income and rising “principal” and I’d be much more happy.
Posted on 2/5/24 at 5:17 pm to Big Scrub TX
quote:
And what sort of premium do they typically garner?
Depends. Sometimes they’re even at a discount (on small quantities).
I’m not completely sure if I understand your use of premium in this context (premium to what?), but I’d buy a brokered CD over a traditional bank CD if I was buying CDs at all. That market based pricing works just like market value fluctuations on bonds.
I have clients that locked in 5% for 5 years on CDs and they’re trading at a significant premium in the secondary market now that new issues are sub 4.5%. It works both ways.
ETA - by the way, I appreciate your USFR thread. I began using it around a year ago for quite a few clients. I had no familiarity with the floating rate treasury market until your thread. Researched it and rich I knew about it in 2022 instead.
This post was edited on 2/5/24 at 5:19 pm
Posted on 2/5/24 at 5:35 pm to slackster
Sounds like a plan, thanks.
Posted on 2/5/24 at 5:56 pm to slackster
quote:I mean rate premium to daily-liquid alternatives. To me, the ONLY reason anyone would ever even consider a CD is if there were some substantial pick up in rate.
I’m not completely sure if I understand your use of premium in this context (premium to what?), but I’d buy a brokered CD over a traditional bank CD if I was buying CDs at all. That market based pricing works just like market value fluctuations on bonds.
quote:
ETA - by the way, I appreciate your USFR thread. I began using it around a year ago for quite a few clients. I had no familiarity with the floating rate treasury market until your thread. Researched it and rich I knew about it in 2022 instead.
Yeah, it was a revelation when I came across it! It's just so perfect for RIGHT NOW.
Posted on 2/5/24 at 7:47 pm to Roscoe14
You may want to consider talking to a financial planner. You may have all this figured out but you probably want to keep some equity exposure if you are nearing retirement age (early to mid-60s?). Maybe I read too much into your post but something to think about.
Posted on 2/5/24 at 9:21 pm to dirtsandwich
I've been buying some of the J P Morgan CD's. It's aggravating that they are all call protected. The non call protected ones are paying significantly (to me) less. I've been buying more 3 and 6 mo. TBills with a few A rated and BBB corporates yielding 6-7ish %. The agency newer issues are all call protected. It's aggravating and no I don't think they pay enough extra % to justify buying them personally. I'm 64 yrs old.
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