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Old 04-22-2011, 07:21 AM   #21
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The only PenFed CD yielding more than 2.5% are the 7 year which is hardly zero duration.
I think you misunderstood my use of the word 'duration' as a bond math concept . . .

Macaulay Duration is a measure of a bond's price sensitivity to changes in interest rates. So yes, a 7 Year PenFed CD (yielding 2.75%) is essentially a zero duration product (5-yr Ally CDs at 2.4%, BTW). Coupled with the fact that they also have relatively low cost put options that can likely be exercised if rates rise, makes them a far better product than a similar yielding bond, or bond fund.
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Old 04-22-2011, 07:24 AM   #22
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you may want to consider accelerating your goals or even go a bit further. In the 2008 crisis, right after I had retired, I experienced over 45% drop in portfolio value. I had a 65/35 allocation. Not good. DW and I had a lot of (one way) conversations on how this happened. Even though we had jointly agreed to our AA previously. Nothing like a real world experience to make one come to reality. ... and truly understand what your risk tolerance (all parties) is.
We now have a 40/60 AA so that we can sleep at night (accomplished fairly recently, as the market has come back closer to the 'high' position that we had experienced).
The good news on this is that we had enough experience under our belts, so that we did not panic at the bottom and dump out.

Hope this helps.
I hear you. My portfolio didn't drop nearly that bad as approx. 20% of my equities are in Utilities which didn't drop nearly so far. And it was nice reinvesting those dividends into lower cost shares. Also my situation is somewhat different in that with my Naval Pension and joint SS we will easily cover our basic costs. The IRAs and investments I have are mainly for entertainment and travel so again, I feel I can hold a somewhat higher % in equities. 2008 was a Mega bear and generally they only come around every 30 years or so (30's, 70's and this last decade)

Unless its "Different this time"
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Old 04-22-2011, 07:47 AM   #23
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I think you misunderstood my use of the word 'duration' as a bond math concept . . .

Macaulay Duration is a measure of a bond's price sensitivity to changes in interest rates. So yes, a 7 Year PenFed CD (yielding 2.75%) is essentially a zero duration product (5-yr Ally CDs at 2.4%, BTW). Coupled with the fact that they also have relatively low cost put options that can likely be exercised if rates rise, makes them a far better product than a similar yielding bond, or bond fund.
While I understand your point, I wouldn't agree that the duration of a 2.75% 7 year CD is zero. Technically, I think it would actually be the same as a 2.75% 7 year bond.

The difference is that there are active markets for bonds so when interest rates rise, prices/value decline as the bonds contractual cash flows are discounted at the higher market discount rate and the decline is more visible. The same thing would happen with a CD - the exchange value of the contractual cash flows would be discounted at the current market rate and the value someone would be willing to pay for those cash flows would be lower because their alternative would be to simply buy a "new" CD at the current market rate.

With both a 7 year CD and a 7 year bond, if you hold to maturity you get a 2.75% return. Though I would agree that the implicit put in the CD makes it preferable to a bond with the same coupon and term.
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Old 04-22-2011, 07:50 AM   #24
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I would think that part of the decision is when you actually are planning on full retirement. AA decisions are also related to your "time in life".

For instance, DW/me were at a 90/10 (equity/bond-cash) for most of our accumulation period.

Five years before we planned to retire (at age 59), we gradually changed our AA to a 60/40 ER target, selling off equities to fund our retirement cash "bucket" (contains 3-4 years of gross income, to avoid selling in a down market - equities or bonds), along with moving equities to bonds, when it made sense.

Being retired four years (at least me - DW decided to stay "in service"), and going through 2008, we've dropped our joint AA to a 50/50 mix (equity/bonds-cash). If equities grow beyond that 50% target (as it has recently) we sell - either to push more to our respective cash buckets and into bonds. Last week, I sold a bit off, reducing our current equity side from 54% to 52%. Now, it's back up again. I'll let it sit (since I believe we're in for a short term downturn due to folks "harvesting" their short term gains - but what do I know) untill it comes up a bit - but not more than 54%.

If you don't expect to retire till age 70 (some do) then you have time to state your intent, and make your changes. However if you decided to retire next year, you are subject to short term market flux, win or lose.
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Old 04-22-2011, 08:15 AM   #25
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While I understand your point, I wouldn't agree that the duration of a 2.75% 7 year CD is zero. Technically, I think it would actually be the same as a 2.75% 7 year bond.
If we're talking about non-brokered CDs, I disagree. Remember that a market would value that put option (early redemption penalty) too, which in the case of Ally CDs is a scant sixty days interest. So even if a liquid market developed tomorrow, a floor price around par would still exist.

If you want to get 'technical' I'd agree that a CD's duration isn't zero. It is a function of its early redemption penalty, the starting coupon, and the change in rates. So in the example of a 200bp increase in rates a 5 year 2.4% Ally CD costs 40bp to reset to 4.4%. that works out to be an equivalent duration of about 0.2 years. Whereas a 2.4% coupon 5-Year treasury bond declines in value by 8.9% with a 200bp increase in yields, for a 4.74 duration (duration isn't linear which is why the decline in value isn't exactly twice the duration). That is a pretty tremendous difference in a perfectly realistic example of 5 year rates rising to 4.4%.

It's important to note here that not all CDs are created equal, and early redemption terms vary widely. Ally is the best I've seen, some others are pretty good, and still others are really bad. So buyer beware.
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Old 04-22-2011, 08:48 AM   #26
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...... Whether the CD's cash flows would be valued differently on the open market is irrelevant because it is not valued on an open market. .....
Part of my point was that the notion of duration doesn't apply well to CDs because duration is a measure of price sensitivity to changes in interest rates and CDs aren't traded on the open market like bonds are. But one could argue that almost any cash flows can be sold and IF the cash flows were sold then the amount someone would be willing to pay for those cash flows would be less than the CD deposit amount (par vlaue) and that price sensitivity could then be measured.

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........Instead, my Ally CD has a sixty day early redemption penalty I can pay to reset the rate at market levels. And besides, the market would also value that put option which would keep the CD trading at roughly anyway. ........
I agree and acknowledged the same on my prior post. I'll admit that the put option is much more attractive than what I thought it would be and it makes the CD much more attractive relative to a bond with similar term and coupon in a period of rising interest rates.
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Old 04-22-2011, 09:01 AM   #27
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Part of my point was that the notion of duration doesn't apply well to CDs because duration is a measure of price sensitivity to changes in interest rates and CDs aren't traded on the open market like bonds are. But one could argue that almost any cash flows can be sold and IF the cash flows were sold then the amount someone would be willing to pay for those cash flows would be less than the CD deposit amount (par vlaue) and that price sensitivity could then be measured.

FYI. I changed the part of my comment that you quoted to be less 'dicky' and also to emphasize a more important point . . . that the market would also value the put option. So in a rising rate environment, CDs with good early redemption terms would still trade around par.

And it still doesn't matter what a market would, or wouldn't do. In either a rising rate environment, or a falling rate environment, I can get my money back at around par. Therefore, a duration of roughly zero is accurate.
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Old 04-22-2011, 09:29 AM   #28
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FYI. I changed the part of my comment that you quoted to be less 'dicky' and also to emphasize a more important point . . . that the market would also value the put option. So in a rising rate environment, CDs with good early redemption terms would still trade around par.

And it still doesn't matter what a market would, or wouldn't do. In either a rising rate environment, or a falling rate environment, I can get my money back at around par. Therefore, a duration of roughly zero is accurate.
A little slow on the ol' keyboard this morning?

Anyhow, with the option I would agree the duration is quite low.
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Old 04-22-2011, 10:22 AM   #29
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I recently received an e-mail from Fidelity that our equity position is too high for our age. They don't know about savings in the banking system so I wasn't concerned. I held Dodge & Cox Balanced and Oakmark Equity & Income which, in theory, are very similar. I moved my Dodge & Cox to the Oakmark product a few months back as the latter performed better during the downturn. Compare the Oakmark fund to both Wellington and Windsor.
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Old 04-22-2011, 11:37 AM   #30
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I recently received an e-mail from Fidelity that our equity position is too high for our age. They don't know about savings in the banking system so I wasn't concerned. I held Dodge & Cox Balanced and Oakmark Equity & Income which, in theory, are very similar. I moved my Dodge & Cox to the Oakmark product a few months back as the latter performed better during the downturn. Compare the Oakmark fund to both Wellington and Windsor.
I have all 3 in about equal proportions. Perhaps I should junk the Windsor, although I do feel good with the Wellington.
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Old 04-22-2011, 01:32 PM   #31
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I hear you. My portfolio didn't drop nearly that bad as approx. 20% of my equities are in Utilities which didn't drop nearly so far. And it was nice reinvesting those dividends into lower cost shares. Also my situation is somewhat different in that with my Naval Pension and joint SS we will easily cover our basic costs. The IRAs and investments I have are mainly for entertainment and travel so again, I feel I can hold a somewhat higher % in equities. 2008 was a Mega bear and generally they only come around every 30 years or so (30's, 70's and this last decade)

Unless its "Different this time"
My megacorp pension covers close to all of our living expenses too. The portfolio IS for fun, travel, and future health expenses. It's a great buffer.
I think we are more alike than different.
My point is that when you see your 'wealth' drop like a rock, you really test your risk tolerance. The good news was that theory and reality came together on the 2008 'test' for me. DW was not so good with it.
It's one thing to understand ... it's another to live through it on a daily basis, not knowing where it's going.

Read 'The Black Swan' by N. Taleb, re: your 'Unless it's different ... ' comment. Not disagreeing with you ... just sharing info
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Old 04-22-2011, 02:07 PM   #32
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n1966 - Jan 2006. Hinsight and rear view mirror analysis of my 'brillant' studing and investing career resulted in a grudging acceptance of my skill level.

1. I tossed in the towel and bought Vanguard Target Retirement 2015 for my retirement money.

2. Recognizing resistance is futile hormone wise - I did lie about my age and kept a 'few good stocks.' You know to keep the hormones under control.

3. Like the trying to get healthy threads on this forum - trying to lose a few pounds, exercise and eat healthy.

heh heh heh - aka almost a Boglehead but still trying for 5% 'animal spirits' active part of portfolio in instead of 10% currently - sort of like keeping after weight, diet and exercise. My rebalancing from stocks to bonds or vice versa is where I now close my eyes and let those Vanguard computers do their thing. Of course I could awake and discover the part I missed my first 40 years of manually rebalancing - or not.
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Old 04-22-2011, 04:46 PM   #33
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If we're talking about non-brokered CDs, I disagree. Remember that a market would value that put option (early redemption penalty) too, which in the case of Ally CDs is a scant sixty days interest. So even if a liquid market developed tomorrow, a floor price around par would still exist.

If you want to get 'technical' I'd agree that a CD's duration isn't zero. It is a function of its early redemption penalty, the starting coupon, and the change in rates. So in the example of a 200bp increase in rates a 5 year 2.4% Ally CD costs 40bp to reset to 4.4%. that works out to be an equivalent duration of about 0.2 years. Whereas a 2.4% coupon 5-Year treasury bond declines in value by 8.9% with a 200bp increase in yields, for a 4.74 duration (duration isn't linear which is why the decline in value isn't exactly twice the duration). That is a pretty tremendous difference in a perfectly realistic example of 5 year rates rising to 4.4%.

It's important to note here that not all CDs are created equal, and early redemption terms vary widely. Ally is the best I've seen, some others are pretty good, and still others are really bad. So buyer beware.
I think that is a very interesting way of looking at CD vs bond, illustrates the value of put that comes "free of charge" with a CD, not to mention the FDIC insurance.

Out of curiosity what is the duration of the 10 year 5% CD, that many of us have it has a 1 year interest early withdrawal penalty.
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Old 04-23-2011, 06:53 AM   #34
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I think that is a very interesting way of looking at CD vs bond, illustrates the value of put that comes "free of charge" with a CD, not to mention the FDIC insurance.

Out of curiosity what is the duration of the 10 year 5% CD, that many of us have it has a 1 year interest early withdrawal penalty.
The put isn't entirely 'free'. You do give up any price appreciation in a declining rate environment with a CD. And higher market prices can be handy for rebalancing, although probably not a big give-up in today's low interest rate environment.

The cost of resetting your 10-YR CD is going to be 5%. If rates rise 200bp, then the equivalent duration would be 2.5 years. The duration of a normal 10-yr bond with a 5% coupon is 8.0 years, for comparison.
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Old 04-23-2011, 07:17 AM   #35
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I recently received an e-mail from Fidelity that our equity position is too high for our age.
You can go into your personal profile and update your target. It might be that you are currently set as a conservative or balanced investor (based upon questions asked on the profile). If you up it a bit on the equity side, you will probably eliminate the notification.

Another thing with Fidelity is that they do an analysis of all the accounts you have on their Full View tool (actually the software comes from Yodlee) which will match your target against all the various funds, savings, etc. that you have signified are for retirement purposes. While my personal account (rollover IRA) at Fidelity is equity heavy - beyond my/DW's joint AA target by itself, when it is combined with my VG Roth/TIRA, along with DW's Fidelity 401(K), VG's Roth/TIRA and 403B accounts, the analysis will show that we're on target vs. our actual holdings.
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Old 04-23-2011, 11:03 AM   #36
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I went online yesterday to take a look at strips and I bonds to match our MRDs. To tell the truth there was nothing there that motivated me to buy. Right now I think equity funds have less investment risk than their bond counterparts. The other option to increase the value of our cash holdings are CDs. Although Fidelity doesn't look at a fund that concentrates on dividend payers as a bond that is where I think I will look.
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