Fear / Greed and AA Part 2

[obgyn65]

Obviously you have missed some interesting threads

If it works for you and your financial plan, who can argue? ...

 

[obgyn65]

Brokered CD.

Was this a brokered CD or a direct purchase from a bank or credit union?

 

[Ready]

Brokered CD.

Interesting. I am curious why you chose a brokered CD over a PenFed CD. The way I look at it, I can lock in a 3% rate for either 5 or 7 years with PenFed. If rates stay the same or go down (unlikely), I just leave the CD in place until maturity. However, if interest rates increase to 5% in the next two years, I can cash out at any time and just pay a flat penalty of one year of interest.

With a brokered CD, if rates rise to 5%, the value of the CD drops pretty substantially, similar to selling a bond prior to maturity in a market with rising interest rates. This interest rate sensitivity associated with brokered CDs in my mind makes them just as "risky" as buying bonds, because the value can drop substantially if interest rates rise. And while you can hold the CD for ten years to get your principal back, you would be stuck holding a 3% CD for 8 years when you could have reinvested into a 5% CD and made substantially higher returns over those 8 years.

So following this logic, if a bank CD with a guaranteed "cap" on the penalty for early withdrawal is a very modest one year of interest, the risk associated with a brokered CD would require that it pay a premium to reward the holder for the risk.

Which brings me to my ultimate question: is an extra .3% interest enough to justify that much risk?

 

[obgyn65]

I get all my CDs from Edward Jones. Much simpler. One statement for tax purposes.

If interest rates go up, I will buy new CDs at new rates and I will pay the penalty - it's a risk I am willing to take.

Interesting. I am curious why you chose a brokered CD over a PenFed CD. The way I look at it, I can lock in a 3% rate for either 5 or 7 years with PenFed. If rates stay the same or go down (unlikely), I just leave the CD in place until maturity. However, if interest rates increase to 5% in the next two years, I can cash out at any time and just pay a flat penalty of one year of interest.

With a brokered CD, if rates rise to 5%, the value of the CD drops pretty substantially, similar to selling a bond prior to maturity in a market with rising interest rates. This interest rate sensitivity associated with brokered CDs in my mind makes them just as "risky" as buying bonds, because the value can drop substantially if interest rates rise. And while you can hold the CD for ten years to get your principal back, you would be stuck holding a 3% CD for 8 years when you could have reinvested into a 5% CD and made substantially higher returns over those 8 years.

So following this logic, if a bank CD with a guaranteed "cap" on the penalty for early withdrawal is a very modest one year of interest, the risk associated with a brokered CD would require that it pay a premium to reward the holder for the risk.

Which brings me to my ultimate question: is an extra .3% interest enough to justify that much risk?