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Dear Dr. Don,
I have looked at model asset allocations for a traditional IRA for a person like me who is recently retired (age 57).
These models always have a bond component.
Am I missing something? Why are bonds preferable to laddered CDs in these model asset allocations? It
seems to me that laddered CDs have more advantages than bonds do when they are in an IRA.
-- Richard Reclassification
Dear Richard,
The typical asset allocation models split investments between financial assets categorized as stocks, bonds or cash. Cash
doesn't mean currency; it's just financial shorthand for money market instruments, which are short-term debt securities
like Treasury bills, commercial paper or a money market mutual fund. Money market investments have a final maturity of a
year or less.
Likewise, the bond component refers to long-term debt securities. CDs with final maturities longer than
a year should be considered as part of your bond allocation when analyzing your asset allocation.
A laddered CD portfolio is comprised of investments in CDs in multiple maturities out to the longest
maturity in your investment horizon. As the nearby CDs mature, the proceeds are reinvested out to the investment horizon.
The idea is similar to dollar-cost averaging in stock investing. With a laddered CD portfolio, the initial
investment is typically made at one point in time, and it's the reinvestment (as the rungs on the ladder mature) that has
you buying long CDs regardless of where interest rates are at that point in time.
The Bankrate feature "How to ladder a CD portfolio" is
one of many features on Bankrate that discuss CD laddering.
One note of caution is that CDs typically don't have maturities as long as bonds. A five-year CD ladder will
never have any exposure to longer-term interest rates. That may be fine based on your attitude toward taking on risk in your
retirement portfolio, but it does make it harder to keep the purchasing power of your investments ahead of inflation.
You should consider this in splitting up a bond allocation between certificates of deposit and other forms of debt. An investment
in inflation-protected securities, like Treasury inflation-protected securities, or TIPS, can be very appropriate in your
bond allocation.
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