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Relying too much on CDs risky

By Claes Bell ·
Monday, March 28, 2011
Posted: 2 pm ET

Rock-bottom CD rates are about as popular with Americans as TSA pat downs and ticket scalpers. Anyone who has money languishing in CDs paying little to no interest is probably pretty annoyed about it.

But if low CD yields are really hurting you -- reducing your ability to meet basic expenses or forcing you to go into debt to make ends meet -- it's possible you're relying too much on CDs in the first place.

Our own Dr. Don has an interesting article this month that touches on the dangers of all-CD portfolios:

My concern with a portfolio that's only invested in CDs is that the investor is overly preoccupied with risk to principal and hasn't considered how purchasing power risk is impacting the value of the portfolio. I'd advise you to get professional advice on managing your portfolio. If you can't get comfortable with the advice, get a second opinion. The Bankrate feature, "Financial planners: not just for millionaires anymore," can help.

You know the disclaimer offered by makers of sugary breakfast cereals? That they're healthy "as part of a balanced breakfast"?

I think the same disclaimer could apply to CDs: They're great as part of a balanced portfolio, but if all you invest in is CDs, your wealth will be eroded as surely as your teeth would be on an all-sugary-cereal diet.

I can understand the allure of an all-CD portfolio, especially in these uncertain times. It's secure, it pays cash interest at regular intervals and laddering can smooth out the rough patches. But just as Dr. Don says, it's important to remember that no investment is entirely risk-free. Sure, your principal is safe, but CDs' real returns rarely outpace inflation. Especially if you're spending your some or all of your CD yields on everyday expenses instead of rolling them into your principal, the spending power of that principal is going to shrink every year.

Especially for retired investors, not wanting to put money into investments that risk principal like stocks and corporate bonds is understandable; in the financial crisis, all-CD investors probably felt like geniuses as the stock market crashed and big, established companies were defaulting on their bonds while their CDs escaped unscathed. But CDs are, in the end, a game of diminishing returns. Even when CD yields are decent, they're going to be paid on an amount of money that is steadily diminishing in value.

I think a better approach is to take Dr. Don's advice and find a fee-only Certified Financial Planner to build you a conservative but balanced portfolio that won't leave you struggling every time CD yields are low.

What do you think? Are all-CD portfolios better than a portfolio with some riskier investments, like stocks and corporate bonds, included?

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March 30, 2011 at 11:03 am

You speak as if the method you suggest is certain to yield the results you want. Nothing could be further from the truth.

What is certain is that by taking your advice, financial planners and stock brokers will make a great living from the fees they charge for managing our money, regardless of whether or not they actually make us any money.

What would be fair is that the fees that money manager's charge, is solely based on the value that they ADD to our account, not on the total value. In otherwords, if you don't make me any money, you don't get paid either. Kinda like pro bono for finacial advisers... But of course you won't do that because then you would be taking the same risk that you are asking us to take, and you're not comfortable with that.

Risk someone's else's money never your own. That is really what this is all about, right?


Claes Bell
March 30, 2011 at 9:49 am

Charles, I think you're right that ultimately, happiness and peace of mind are the most important thing when it comes to investing decisions. My point here is that if the movement of interest rates is stressing people out and diminishing their standard of living, they may want to look into diversifying their portfolio. But if an all-CD and Treasury portfolio is meeting your needs all the way around, and low rates are at worst and inconvenience for you, then it seems like you're in the right place with your investments. Thanks for reading and thanks for your insightful comment.

Charles Rechlin
March 30, 2011 at 9:42 am

Beginning in 2003, I adopted a philosophy of investing only in short or medium maturity debt instruments backed by the full faith and credit of the United States Government. That means all CDs and Treasuries. Given current rate differentials, substantially all my current portfolio consists of CDs. When Ben Bernanke finally gets out of the way, I'll probably go back to mostly Treasuries.

My approach is based on two factors. First, I need a certain amount of income to maintain my lifestyle, which fixed-income instruments offer me. Second, having retired after over 35 years practicing with a Wall Street law firm, specializing in the financial services industry, I am familiar with how markets and investment professionals operate. Any day, I'll take the knowledge that my principal value will eventually erode over the risks of relying on financial advice and financial markets to protect my net worth. Over the long term, an investor is going to get burned unless he or she is willing to spend substantial time watching over a porfolio and to ignore the advice of so-called experts.

I just hate where rates are now. Inflation is going to chip away at my nest-egg, if not eat it alive. But I still sleep better at night than I would if was constantly worrying about what's going to happen next to rattle the financial markets. I lived too long with that, and need a permanent break.