Thinking of moving from bonds to CDs

[pb4uski]

My historical "go-to" bond fund was the Vanguard Total Bond Market Index Fund Admiral Shares (VBTLX) which has a 1.56% SEC yield and a duration of 5.3 years.

About a year ago I transferred most of my fixed income allocation to Vanguard Intermediate-Term Investment-Grade Fund Admiral Shares (VFIDX) which currently has a 2.11% SEC yield and a duration of 5.3 years (average maturity of 6.4 years).

This is in my Vanguard IRA for tax efficiency.

I'm thinking of using 5-year CDs instead of bond funds for my domestic fixed income allocation and using the new VG international bond fund for my international fixed income allocation. I don't anticipate touching these funds at all in the next 10 years.

I see that 5 year CD rates are in the 1.50-1.75% range. I'm thinking that the credit and interest rate risk associated with VFIDX isn't worth and extra .61%-.36%. Thoughts?

Also, does anyone know whether I can buy/hold these non-Vanguard CDs in my Vanguard IRA or would I need to create an IRA with each financial institution that I am buying a CD from and rollover money from my Vanguard IRA to the new IRA accounts?

 

[brewer12345]

I have a 30+% fixed income allocation, but only a third of it is in bond funds. The rest is in I bonds, CDs, a couple of shrter term individual junk bonds I expect to liquidate within a year and cash. I think you will want to maintain at least some bond exposure so that you can rebalance relatively easily.

If you want to buy CDs, there are two ways to do it in an IRA. You can either shop around for the best rates and then create a separate IRA at each new bank (a PITA), or you can use the brokerage account option at VG to buy brokered CDs. The latter is definitely the easy option, but brokered CDs are not surrenderable prior to maturity so if you want to liquidate them you would need to sell them on the open market for whatever you can get. If rates have risen significantly since you bought, you would have to take a discount. Obviously this would not matter if you just held to maturity.

 

[Dawg52]

The latter is definitely the easy option, but brokered CDs are not surrenderable prior to maturity so if you want to liquidate them you would need to sell them on the open market for whatever you can get. If rates have risen significantly since you bought, you would have to take a discount. Obviously this would not matter if you just held to maturity.

Plus rates are not as competitive through your broker. Not as good as what pb4uski mentioned. At Fidelity, the best 5 year rate is 1.2%. Pretty much the same in the secondary market. PFCU is 1.16% for 5 years. Pretty pitiful.

 

[pb4uski]

Good point that I hadn't though of on keeping some bond funds so it is easier to rebalance.

It looks like the brokerage CDs available are ~50 bps lower than the best available rates so while it may be a PITA, it seems like it would be worth the extra effort vs brokerage CDs. I was afraid that might be the case.

Funny thing. I never thought that I would ever buy a CD but interest rate risk is scaring me and it seems that CDs are the optimal means of escape at this juncture.

 

[heeyy_joe]

Better off in a preferred stock ETF.

 

[enjoyinglife102]

I've always held a good portion of my fixed income allocation in CD's shopping around for the best rates and creating a ladder. I agree that it is a relative PITA compared to just holding a fund or even going the brokered CD route. However, for a 5 year 100k CD, 1.8% compared to the brokered 1.2% results in 3k in income over the term. Nice also to have a part of my portfilio not change in value like a bond fund, only throw off income (as small as that may be these days) and the maturing ladder enables me to capture the most current rates. Given all that, the PITA is well worth it to me.

 

[Dawg52]

Better off in a preferred stock ETF.

I'm not opposed to taking on a little more risk, but preferred stock is a potential time bomb as bonds. Maybe a small portion here, but you are taking on a lot more risk.

Danger: Unexploded Bomb In Your Preferred Stock Portfolio - Seeking Alpha

 

[FIREd]

I bought into "the new normal" theory early on and piled heavily into longer term CDs in 2010. So my CD ladder still yields a pretty solid ~4% and should continue to do so for at least 4 more years. With the latest run in the stock market, I have to once again add to my fixed income allocation. I bought some i-bonds in late April as well as some CDs. For the latter, I picked the 4-year raise-your-rate CD at Ally (@1.3%). The premium for the raise-your-rate feature was incredibly cheap. I also bought more munis since they seem to offer the best bang for the buck in the bond universe right now.

 

[Ready]

Another good thing to keep in mind about Ally Bank is that their penalty for early withdrawal is only 60 days of interest, whereas most banks ding you for an entire year. I've been using Ally's 5 year CD's exclusively for a while, and I recently cashed some in to buy equities, but I still have quite a few at about 3.5% interest that I'm just leaving untouched. It's less risky than bonds and a bit higher interest, although the interest is of course taxable. Municipal bonds are tax free, but you have the interest rate risk to deal with.

 

[heeyy_joe]

I'm not opposed to taking on a little more risk, but preferred stock is a potential time bomb as bonds. Maybe a small portion here, but you are taking on a lot more risk.

Danger: Unexploded Bomb In Your Preferred Stock Portfolio - Seeking Alpha

To each his own of course, but when relating risk to reward, preferred stock is a good way to lower risk from bonds while enjoying more reward than CD's. Personally, I prefer individual issues (rather than etf's) that I am willing to buy and hold at least through the call protection date and the issue has to be Moody's rated at least Baa2.

 

[brewer12345]

To each his own of course, but when relating risk to reward, preferred stock is a good way to lower risk from bonds while enjoying more reward than CD's. Personally, I prefer individual issues (rather than etf's) that I am willing to buy and hold at least through the call protection date and the issue has to be Moody's rated at least Baa2.

You are smoking dope if you think preferreds are less risky than an investment grade bond fund.

 

[Midpack]

I think it's a good question, but all my bond funds are in IRAs so I can't venture outside Vanguard (that I know of). So I took a pic of their current rates...sigh (1.2% for 5 yrs). I am not worried short term, but I will probably be looking for a way out of VBTLX & VFSUX in 2014-15 if not before. Timing sucks...

 

[heeyy_joe]

You are smoking dope if you think preferreds are less risky than an investment grade bond fund.

Hmmm....never mention investment grade bonds.

 

[brewer12345]

Hmmm....never mention investment grade bonds.

Umm, then wtf were you talking about?

preferred stock is a good way to lower risk from bonds while enjoying more reward than CD's

 

[heeyy_joe]

Umm, then wtf were you talking about?

junk

 

[brewer12345]

junk

Its debatable whether preferreds are safer than junk, IMO. A junk bond and a preferred default: which one gets a higher recovery?

 

[pb4uski]

I think it's a good question, but all my bond funds are in IRAs so I can't venture outside Vanguard (that I know of). So I took a pic of their current rates...sigh (1.2% for 5 yrs). I am not worried short term, but I will probably be looking for a way out of VBTLX & VFSUX in 2014-15 if not before. Timing sucks...

I'm all in Vanguard as well. What I will have to do is establish an IRA with the bank, sell VFIDX in my Vanguard IRA, transfer funds from my Vanguard IRA to the bank IRA and then buy a CD from the bank that will be held by the bank IRA. I'll need to do more than one since I don't want to exceed the FDIC limit.

That is the PITA we were referring to before, but for 2.5% (50bps/year for 5 years) it seems like the upfront effort would be worth it.

 

[veremchuka]

I hear your concerns. I keep a lot of my tax deferred in my 401k for the 3.2% stable value fund yield, no issues with duration. As mentioned, rebalancing is a PITA if you have CD's at Ally or elsewhere so this is one reason I have not put anything into CD's. I have an allocation to the Vanguard Investment Grade Bond fund too but it has a longish duration and TIPS fund which is almost 2x as bad so like you I worry. Preferred stocks are no more acceptable as FI than junk bonds so I'd ignore that option.

 

[FIREd]

I keep a lot of my tax deferred in my 401k for the 3.2% stable value fund yield, no issues with duration.

How do those "stable value funds" work? How can they do what no one else can do - provide a high yield risk free? I wish I had access to one...

 

[F4mandolin]

So why not hold cash, or a short term CD for the next year (instead of bonds)....then IFFFF % rates rise.....wouldn't the CD market get a boost? And then roll over to the next higher CD rate? Or as usual......I'm clueless in Nine Mile Falls.....At least my golf game is coming around......

 

[steelyman]

How do those "stable value funds" work? How can they do what no one else can do - provide a high yield risk free? I wish I had access to one...

I looked into this because there is one option, run by Invesco, in our 457 plan. My (limited) knowledge is that they invest in fixed income (bonds) but also enter into "wrap contracts" with insurers to improve the return.

A Google search will turn up probably better info, including losses incurred by employees of Lehman Bros back when it hit the fan. I think that is rare and I have $$ in the 457 offering.

I also think they should be more widely available.

 

[FIRE'd@51]

heevy_joe

You should also realize that the interest-rate risk of preferred stock can be very high. The duration of a preferred is approximately the inverse of its yield. So a preferred stock yielding 6% has a duration of about 16.

 

[rjohnla]

Bond Funds? Absolutely & now. In A rated banks only. Check Wiess Bank ratings.

 

[brewer12345]

I looked into this because there is one option, run by Invesco, in our 457 plan. My (limited) knowledge is that they invest in fixed income (bonds) but also enter into "wrap contracts" with insurers to improve the return.

A Google search will turn up probably better info, including losses incurred by employees of Lehman Bros back when it hit the fan. I think that is rare and I have $$ in the 457 offering.

I also think they should be more widely available.

Partially correct. I have been following this business for years in a professional capacity. Basically the stable value manager buys a pool of short to medium term (usually not more than 5 years maturity) bonds of very high credit quality (routinely AA average quality). They then contract with several banks and insurers to extend a guarantee to always keep the value at par. They usually pay the guarantors a pittance (at the absolute height of the market disaster guarantors were getting paid maybe .25% a year for these guarantees). If you have one of these funds available to you, I would jump on it as a stand-in for bond exposure.

 

[steelyman]

... to always keep the value at par.

I think that's the part that comes from people who know the lingo. Change "improve" to "preserve" in my post.

Thanks!