CD's & Anti-Inflation strategies

[JohnR]

What strategies do people use to protect against (or minimize) inflation - beyond CD laddering?
For instance, what SWR approaches are used to counter inflation?

I ask as much as a question of discipline, I'd be very tempted to spend the income from a 4% or less CD all too easily, as opposed to reinvesting a portion to offset inflation. Is it true to say CD's normally do not compound interest? And are the interest payments normally added to the original amount or paid out to say a MM account?

 

[uncledrz]

What strategies do people use to protect against (or minimize) inflation - beyond CD laddering?

In broad strokes hard assets such as real estate and commodities and stocks of companies which have pricing power are used to protect against inflation. Inflation adjusted bonds such as TIPS are designed to have an element of inflation protection. Whether any of these investments is appropriate at this time I'll leave to your decision. Keep in mind that the inflation hedge is not always immediate.

 

[Mr._johngalt]

Real estate with a CD ladder should be fine IMHO.

JG

 

[Janie]

John,

Typically, CDs at banks or credit unions compound the interest daily or monthly and the interest is just added to your CD- so you earn interest on the interest as you go. The stated rate is typically the APR, so it accounts for the fact that interest is compounded.

Right now Pentagon Fed Credit Union offers 3-yr CDs at 5%. You have to become a member ($20), but the nice part is that they have practically no fees for services like establishing an IRA CD- other banks get you here.

This type of investment only provides an inflation hedge as long as inflation stays below 5%, and provided that you reinvest much of the interest (3% of the 5%, at current inflation rate).

Hope this helps

Janie

 

[charlie]

Another neat thing about Penfed is that if you
have IRA money in a long term CD and are over
59.5, you can cancel the CD at any time without
penalty and re-open a higher rate CD. What a
perfect way to track rates as they climb and hold
when they fall.

Cheers,

Charlie

 

[Nords]

What strategies do people use to protect against (or minimize) inflation - beyond CD laddering?

Hmmm, I thought CDs lagged inflation. Laddering is just a DCA method of ensuring that CDs aren't long & wrong.

Stocks have regularly beat inflation, but that strategy is subject to short-term losses & volatility. Hard assets can also beat inflation, but it's difficult to tell whether it's inflation or just a depreciating dollar. (Is there a difference? I guess the former is when everyone is paying more, the latter when Americans are paying more.)

For instance, what SWR approaches are used to counter inflation?

Conventional wisdom says that you raise your annual SWR by the previous year's rate of inflation (whatever that's judged to be-- CPI or your personal inflation rate or some other number). You could also counter inflation by reducing your spending but this usually produces a vicious downward spiral in your quality of life.

I ask as much as a question of discipline, I'd be very tempted to spend the income from a 4% or less CD all too easily, as opposed to reinvesting a portion to offset inflation. Is it true to say CD's normally do not compound interest? And are the interest payments normally added to the original amount or paid out to say a MM account?

I don't think CDs are an effective method to counter inflation. Most people spend CD income so that their stocks can continue to accrue their gains. But portfolio spending should largely be done to keep your asset allocation in line-- harvesting winners and perhaps pruning losers.

CDs do compound interest, but the results depend on whether that's daily/monthly/quarterly. For example NFCU compounds daily or monthly. The income can be left to compound on the compounding or it can be withdrawn for spending. (Of course withdrawing the income reduces the CD's final yield.) Compounding is the default, but you could probably set up the income to be deposited elsewhere (presumably at a lower interest rate).

 

[JohnR]

Thanks for all the info. Appreciate that CD's aren't the wisest choice but need to diversify and get out of over-priced RE while learning more about funds & stocks. Might leave half in RE as JG suggested.

Suppose Tips are an option if their respective rates ever hit 3% again. Are there any TIPS fans out there that locked in long term high rates when they were first issued? Does the face value of Treasuries (1M or whatever) have any real meaning or significance, when one can buy blocks in $1000 increments anyway?

People seem to have had good experiences with Penfed, good to know. Must look into IRA CD's Any other restrictions or catches? . . . Checked eligibility, wasn't except for joining the NMFA!?. Seems if you pay a small subscription you can otherwise take advantage of Penfed. What is this org, any downsides to joining?

 

[fletzie]

Unless I am mistaken Pen Fed is the Pentagon Federal Credit Union. Anyone who is military can join I think. I was able to join as a contractor at an Army facility although I am not military. I never joined the NMFA...so don't know if it is required.

Has anyone thought of laddering Treasury Bonds?

 

[azanon]

What strategies do people use to protect against (or minimize) inflation - beyond CD laddering?

Domestic and international stock mutual funds.

 

[charlie]

JohnR, there are no downsides to joining Penfed
as far as I can determine. I recently bought some
5% 3 yr CD's there. You can set up the CD's so
that the interest is compounded or paid to you
automatically by check or transfered to a MM
account (with checking) or a savings account.

You can set up the CD so that it rolls over to a
similar CD or is deposited to the account of your
choice or is sent to you via check.

I have already committed the bulk of my IRA fixed
income in floating rate CD's with Vanguard, but
may transfer some funds to a 7 yr CD at Penfed.
in the future to take advantage of the "put" with
no penalty feature that allows tracking of interest
rates.

Cheers,

Charlie

 

[Marshac]

Unless I am mistaken Pen Fed is the Pentagon Federal Credit Union. Anyone who is military can join I think.

True, but in reality anyone can join simply by joining NMFA first, then opening up an account at PenFed.

 

[charlie]

I am surprised that nobody has mentioned I-Bonds
yet so I will. New I-bonds purchased today pay
1% plus CPI (reset semi-annually). Currently they
pay 3.67% but the next reset is in May and they
may change. Personally, since short rates are
still climbing and many expect they won't stop rising
anytime soon, I expect the real rate on I-bonds to
be raised a tad to keep them competitive. But
who knows? Stay tuned.

Cheers,

Charlie

 

[cute fuzzy bunny]

If ibonds or tips gave a better yield I'd consider them...right now cd's and short bonds look pretty good.

For inflation proofing and current income, I use vanguards Wellesley fund. It currently pays a 4% yield - your basic HSWR - and has a total annual return since its inception thats slightly higher than 4%+inflation. A clump of higher volatility large cap value is ballasted by high quality intermediate bonds.

I keep a cash buffer of emergency money in cd's and high yield money markets; those produce enough interest income to offset todays (reported) inflation rates with a little extra on top.

Besides the wellesley core holding, I have some wellington, some foreign, some energy and some precious metals...which all give me a little more upside in the event of higher rates of inflation.

My IRA is loaded with REIT, Health Care, Emerging Markets, small cap value and international small cap. I wont be touching it for ~20 years. In the event that inflation eats away at my very conservative core taxable portfolio that I'm withdrawing from, the IRA should provide a handy recharge that will take me into my 90's. Our Roths feature vanguards asset allocation and tips funds in 70/30 allocations and will give us some lobster money.

I wouldnt put a lot of cash into cd's to 'fight inflation' though, just enough to make sure you dont have to sell deflated shares when you really dont want to but still have your cash fund away from deflation.

 

[fletzie]

Marshac:

Thanks for the additional info! I know several people who would like to do just that!

CF

 

[Ol_Rancher]

Marshac or fletze,

What is NFMA ? A google will get you National Forresrty Management Act; National Flea Market Asoc; National Farm Managers Assoc.;Neighborhood Farmers Market Alliance; National French Mondain Assoc.; National Furniture Manufactures Assoc.; and many more.

Help! all I want t o do is find some way to join PenFed?

 

[Martha]

Join the National Military Family Association. You can do it right on the Penfed.com web site and pay the fee. Just go through the checklist they have you go through to see if you are eligible to be a member. If you don't otherwise qualify, they let you sign up to be a member of NMFA.

Worked fine for me.

 

[cute fuzzy bunny]

Question on that...I noticed they had a 1 year membership or "best value" lifetime membership...do you need to renew that membership annually to stay a penfed member or is it once joined, always a member?

DCU requires non-company-affilliated applications to 'join' one of two inexpensive groups, but you only need to be a member at the time of application, you dont need to renew after that first year...

 

[Marshac]

You can terminate your membership and still remain a PenFed customer... I had the same question when I first joined

 

[cute fuzzy bunny]

Ah, so the 'best value' lifetime membership is anything but a 'best value'...mmm hmmmm...it always seems to work out that way...

 

[JohnR]

I use vanguards Wellesley fund.  It currently pays a 4% yield - your basic HSWR - and has a total annual return since its inception thats slightly higher than 4%+inflation.  A clump of higher volatility large cap value is ballasted by high quality intermediate bonds.

Very useful return th.
Like to be more adventurous but the absence of FDIC makes me a doubting Thomas!

Compelled to ask, are there credit issues using this approach as a long term source of income? Can Vanguard or competitor potentially default with loss of nest egg? I've heard some Tracker style bonds have at least 90% percent capital protection, is the Wellesley fund in this vain?

 

[cute fuzzy bunny]

I suppose vanguard could tank and take part of it. I remember seeing something about investments being insured against bankruptcy types of things but honestly I'd have to look again. The stock and bond holdings are pretty dang blue chippy, so I'm not too worried about the piece parts. Not super worried about vanguard going out of business in the next 10+ years either.

 

[JohnR]

Not super worried about vanguard going out of business in the next 10+ years either.

Are you taking a leap of faith th? It Prompts the question how would we know?
After all the rating agencies (Moody's S&P etc) 'helpfully' only responded to junking Enron and WorldCom - AFTER the scandals broke! We know the pressure and incentives on senior Execs to perform and hit the numbers is high, it focuses on the short term and may hurt long term investors.

Can't hit the numbers? Then get creative. Case in point recent weeks revelations from AIG where 'reinsurance' was used to make the health of AIG and many of their customers look better than it was. Or Coca-Cola where they robbed from future earnings.

How can we be sure we've seen the last of these?, senior Execs could be working on new masking tricks as we speak. And what's with 'deferred prosecutions', doesn't this really just hurt investors in general, while acting as get out of jail free cards for bad management?

Funds firms should be subject to the most stringent regulation with verifiable excess reserves, and guarantees not just for the creditors! Can we say this about Vanguard or any other fund?

 

[charlie]

JohnR, "nothing ventured nothing gained". Wellesley
has been a steady performer for nearly 40 years.
You sound like my 89 year old depression era mom
who only bought CD's or EE bonds until I introduced
her to Wellesley. I use Wellesley and Penfed in my
taxable account for steady income with some growth.

Cheers,

Charlie

 

[brewer12345]

Are you taking a leap of faith th? It Prompts the question how would we know?
After all the rating agencies (Moody's S&P etc) 'helpfully' only responded to junking Enron and WorldCom - AFTER the scandals broke! We know the pressure and incentives on senior Execs to perform and hit the numbers is high, it focuses on the short term and may hurt long term investors.

Can't hit the numbers? Then get creative. Case in point recent weeks revelations from AIG where 'reinsurance' was used to make the health of AIG and many of their customers look better than it was. Or Coca-Cola where they robbed from future earnings.

How can we be sure we've seen the last of these?, senior Execs could be working on new masking tricks as we speak. And what's with 'deferred prosecutions', doesn't this really just hurt investors in general, while acting as get out of jail free cards for bad management?

Funds firms should be subject to the most stringent regulation with verifiable excess reserves, and guarantees not just for the creditors! Can we say this about Vanguard or any other fund?

Its a little bit different situation here. The owners of the mutual fund shares (i.e. the retail investors) legally own the underlying assets. Technically, each fund has a theoretically independent board of directors which can hire or fire a fund manager. So, in theory, the board of VWELX could fire Wellington Management and Vanguard and hire somebody else. If Vanguard went BK, it might be inconvenient, but the board would either hire a new manager, or distribute the aseets.

I personally think that you are far better off with Vanguard because it is a Mutual. That means that the fund shareholders technically own the company. IMO, mutuals are the best organizations to do business with, provided they take the fiduciary duty to act in the owners' best interests seriously. The big, well-run mutuals (like Vanguard, TIAA-CREF, MassMutual, USAA, State Farm, etc.) are all good examples of this.

 

[Mr._johngalt]

HI Charlie! If I was advising my 85 year old Mom,
I would put her into CDs and EE bonds

JG