Using CD Investments Like a Self Managed Annuity Question?

[audreyh1]

William Bernstein advises retirees and near-retirees to avoid investing in risky assets such as stocks, at least with money needed to provide an adequate income stream. Is anybody acting on this advice and what is your strategy?

“In other words, once the game has been won by accumulating enough safe assets to retire on, it makes little sense to keep playing it, at least with the “number”: the pile of safe assets sufficient to directly provide or indirectly purchase an adequate lifetime income stream.”

This is what I would like to discuss. I think it may be referred to as preservation of capital, as opposed to accumulation.

No, I am not acting on his new advice, because I made it through the 2008 crisis without making the major mistakes some of his clients did. I even managed to buy more stocks at the bottoms because I rebalanced, even thought it was an unbelievably difficult thing to do, psychologically speaking.

 

[pb4uski]

+1 I'm following his old advice.

 

[Red Badger]

Our answer to that is to hold TIPS as inflation insurance. I consider any shortfall between the TIPS total return and any alternatives to simply be an insurance premium payment.

Also, if we really get some exciting inflation I expect the TIPS to be bid up well beyond their bond-calculator value by panicked buyers. This will be exacerbated because Treasure will stop selling new TIPS in order to not be pouring gasoline on the fire. So we will make some money there.

To belabor the point, TIPS are inflation insurance just like I buy fire insurance on our houses. I won't be disappointed if we don't get the inflation any more than I would be disappointed if we didn't have a house burn down. Both are low-probability, high-impact events though the house fire IMO is lower probability than a period of exciting inflation.

+1.

TIPS make up ~50% of our bond holdings. I too will be happy if my WIN button stays in the souvenir box

 

[Dash man]

Just like investments need to be diversified, IMO, so does risk of inflation. TIPS are fine as a part of that, but need to be in an IRA to avoid annual tax hits. Real Estate investments can help beat inflation in two ways: rent increases and appreciation of the property you hold. Dividends in strong companies that give regular income and often see increases every year for the best companies. Precious metals, the physical kind and not the over leveraged ETFs, provide some protection, though since they do not pay you dividends no more than 5-10% should be in your portfolio.
Bonds, CDs and cash are losers in a high inflationary environment since interest rates will rise to combat high inflation.

 

[OldShooter]

Just like investments need to be diversified, IMO, so does risk of inflation. TIPS are fine as a part of that, but need to be in an IRA to avoid annual tax hits. Real Estate investments can help beat inflation in two ways: rent increases and appreciation of the property you hold. Dividends in strong companies that give regular income and often see increases every year for the best companies. Precious metals, the physical kind and not the over leveraged ETFs, provide some protection, though since they do not pay you dividends no more than 5-10% should be in your portfolio.
Bonds, CDs and cash are losers in a high inflationary environment since interest rates will rise to combat high inflation.

Well, the reason for diversification is to reduce risk. With TIPS the risk is negligible; the buyer will get what is promised. So WADR I think precious metals on top of a TIPS portfolio only add risk to a risk-free investment. And I mean real risk, not just Markowitz' idea that volatility is risk.

Real estate is a little different. Without leverage, IMO the risk of holding individual properties far outweighs the benefit. (And I have held many individual properties over the years.) Leveraged with fixed-rate financing in inflationary times, of course, holding individual properties can be wonderful. But that is not really just hedging inflation.

Using REITs, the risk of holding individual properties should be diversified away, but without leverage you have to believe that the properties will appreciate more than inflation or risk-free TIPS are the better choice. Leveraged REITs, OTOH, may be attractive.

Dividends, same issue. As an inflation hedge they are much riskier than TIPS. So they can only be attractive if you're expecting them to grow in excess of inflation -- in excess of what you could get from TIPS. Otherwise, why add the risk?

 

[Dash man]

Well, the reason for diversification is to reduce risk. With TIPS the risk is negligible; the buyer will get what is promised. So WADR I think precious metals on top of a TIPS portfolio only add risk to a risk-free investment. And I mean real risk, not just Markowitz' idea that volatility is risk.

Real estate is a little different. Without leverage, IMO the risk of holding individual properties far outweighs the benefit. (And I have held many individual properties over the years.) Leveraged with fixed-rate financing in inflationary times, of course, holding individual properties can be wonderful. But that is not really just hedging inflation.

Using REITs, the risk of holding individual properties should be diversified away, but without leverage you have to believe that the properties will appreciate more than inflation or risk-free TIPS are the better choice. Leveraged REITs, OTOH, may be attractive.

Dividends, same issue. As an inflation hedge they are much riskier than TIPS. So they can only be attractive if you're expecting them to grow in excess of inflation -- in excess of what you could get from TIPS. Otherwise, why add the risk?

You obviously trust the government more than I do to pay what is promised. There is risk when the government can change the rules or debt levels get so high that default does become a possibility. Big test will be if we get a big SS haircut in a few years.
I personally draw the line on leveraging any investment. That increases the risk exponentially with real estate and any other investments. Don’t have to look too far back to 2008 to remember those who lost properties because they were too highly leveraged. Hedge funds are dropping like flies because of too much leverage hurting many investors.
I thought this topic was about staying conservative. All eggs in one basket...including TIPS is not conservative. Enjoy the tax bill if you’re not in a Roth.

 

[OldShooter]

You obviously trust the government more than I do to pay what is promised. There is risk when the government can change the rules or debt levels get so high that default does become a possibility. Big test will be if we get a big SS haircut in a few years.
I personally draw the line on leveraging any investment. That increases the risk exponentially with real estate and any other investments. Don’t have to look too far back to 2008 to remember those who lost properties because they were too highly leveraged. Hedge funds are dropping like flies because of too much leverage hurting many investors.
I thought this topic was about staying conservative. All eggs in one basket...including TIPS is not conservative. Enjoy the tax bill if you’re not in a Roth.

Yup. All true if you don't trust the gummint to deliver on its promises the TIPS are not zero risk and all the arguments for diversification come into play. Re leverage I generally agree, but I bought a lot of residential real estate with 20% down and it worked just fine. I was done by the time the housing bubble inflated but I could see that train wreck coming as could many others. But no one knew when and virtually everyone was astonished by the scope. We had some friends that bought a couple of investment houses during that period and we just cringed and kept our mouths shut. Hard to do, actually, and they did lose a bundle.

I guess if you don't think TIPS are conservative that is a pretty fundamental difference. For myself, I don't see precious metals as conservative so I guess we can just agree to disagree.

Re taxes on TIPS ours are in IRAs but I don't think the tiny annual negative cash flow should be a big deal to most people. I guess if we see 15% inflation again it could be a little exciting but at that point I'll be ecstatic to have the TIPS. YMMV of course.

 

[brucethebroker]

Collins had a great interview with a retiree/advisor on this very topic. His pal, "Mr. Moose" has a plan that might be of interest to you.

Sleeping soundly thru a market crash: The Wasting Asset Retirement Model

 

[ShokWaveRider]

Collins had a great interview with a retiree/advisor on this very topic. His pal, "Mr. Moose" has a plan that might be of interest to you.

Sleeping soundly thru a market crash: The Wasting Asset Retirement Model

I like WARM......

 

[copyright1997reloaded]

You obviously trust the government more than I do to pay what is promised. There is risk when the government can change the rules or debt levels get so high that default does become a possibility. Big test will be if we get a big SS haircut in a few years.
I personally draw the line on leveraging any investment. That increases the risk exponentially with real estate and any other investments. Don’t have to look too far back to 2008 to remember those who lost properties because they were too highly leveraged. Hedge funds are dropping like flies because of too much leverage hurting many investors.
I thought this topic was about staying conservative. All eggs in one basket...including TIPS is not conservative. Enjoy the tax bill if you’re not in a Roth.

I don't trust the government. But there is no reason the government would default on debts issued in its own currency. They can simply print more.
. That is a reason why I favor TIPS over other debt instruments which pay back using nominal (non-inflation-adjusted) currency. Is it perfect? Not by a long shot. That is why I also have non US assets, and things like land and other things that have an inflation hedge to them.

 

[Perryinva]

If one can can basically live on CD or similar interest earned plus a small reduction in principle, then doesn’t it become inflation protected anyway, since CD rates always rise with inflation? The net is all that matters.

 

[copyright1997reloaded]

Not us, I can resist easily. I do not need the headaches or the loss of sleep, that seems to plague me when doing anything involved with the stock market .

Quite honestly, if we just took the stash divided it by 35 years (No Interest or return) we would be more than comfortable. I would like to get 3 - 4% for "Insurance".

DW DOES currently use the ACA. It is a consideration.

Once again, you still have risk. Loss of capital is only one type of risk. Inflation risk is another. If I could invest my capital in a way that would simply allow me to withdraw it over 35 years and be guaranteed today's buying power I WOULD DO SO IN A NANOSECOND.

 

[Dtail]

If one can can basically live on CD or similar interest earned plus a small reduction in principle, then doesn’t it become inflation protected anyway, since CD rates always rise with inflation? The net is all that matters.

Was thinking the same thing too, but what about this scenario?
Forget the exact math.

If product A costs 100 and the CD rate is 2% and inflation is 2%.
Inflation and CD rate go up to 4%. Product A goes up to 102.

Now Inflation and CD rate go back down to 2%, but you know the product is still at 102.
So now one is earning the same lower interest whether the product is at 102 or 104. Thus is CD is not keeping up with the cost of goods?
Am I missing something?
Is my example too simple?

 

[Perryinva]

No, that is a good example, as well as the fact that rates don't track inflation exactly anyway, its a broad stroke. So if you buy a 5 year CD, then inflation tanks, you are beating it, and vice versa. On a large scale, WHILE the rate was high you profited. Rates will never track fast steep changes in inflation , its just a rolling average that is compounded. The idea is that when the rates increased, your principal increased and is now earning more, which levels the playing field on the increased price. It is the rate of change that matters, not the absolute price.

 

[pb4uski]

So in your examp!e, what are the CD balances and cost of product A at the end of years 1, 2 and 3?

 

[brokrken]

Was thinking the same thing too, but what about this scenario?
Forget the exact math.

If product A costs 100 and the CD rate is 2% and inflation is 2%.
Inflation and CD rate go up to 4%. Product A goes up to 102.

Now Inflation and CD rate go back down to 2%, but you know the product is still at 102.
So now one is earning the same lower interest whether the product is at 102 or 104. Thus is CD is not keeping up with the cost of goods?
Am I missing something?
Is my example too simple?

I think this is why you would ladder the CDs, right?

 

[Dtail]

No, that is a good example, as well as the fact that rates don't track inflation exactly anyway, its a broad stroke. So if you buy a 5 year CD, then inflation tanks, you are beating it, and vice versa. On a large scale, WHILE the rate was high you profited. Rates will never track fast steep changes in inflation , its just a rolling average that is compounded. The idea is that when the rates increased, your principal increased and is now earning more, which levels the playing field on the increased price. It is the rate of change that matters, not the absolute price.

So in the end, do you feel that with a mainly CD type only portfolio which is covering expenses to be safe enough?

So in your examp!e, what are the CD balances and cost of product A at the end of years 1, 2 and 3?

I don't have specific balances; was just angling on the CD portfolio concept in higher/lower inflation rate scenarios.

 

[Dtail]

I think this is why you would ladder the CDs, right?

True, true

 

[ShokWaveRider]

OK, so I think the consensus is that a CD Ladder works best. I am a little confused how to create one that give off Maximum interest over a 5 year period without buying all 5 year CDS. What I mean is, unless you buy 5 year CDs with all your cash, you are going to forfeit some interest in the lower denominations to create the ladder.

In this example: $1m invested in CDS to maximize the $250k FDIC safety net. The Rates are hypothetical.

1 x $250k 5 year CD at 3%
1 x $250k 4 year CD at 2.75%
1 x $250k 2 year CD at 2.35%
1 x $250k 1 year CD at 2%

This is a lot less than buying 4 x 5year CDS but your full cash is tied up for the total period.

 

[Another Reader]

OK, so I think the consensus is that a CD Ladder works best. I am a little confused how to create one that give off Maximum interest over a 5 year period without buying all 5 year CDS. What I mean is, unless you buy 5 year CDs with all your cash, you are going to forfeit some interest in the lower denominations to create the ladder.

In this example: $1m invested in CDS to maximize the $250k FDIC safety net. The Rates are hypothetical.

1 x $250k 5 year CD at 3%
1 x $250k 4 year CD at 2.75%
1 x $250k 2 year CD at 2.35%
1 x $250k 1 year CD at 2%

This is a lot less than buying 4 x 5year CDS but your full cash is tied up for the total period.

In a rising interest rate environment, your income will go up as you renew. When interest rates are falling, you lock in longer terms, as all those PenFed 3 percent five year CD holders did. The ladder approach appears to be the way to go today.

 

[RE2Boys]

1 x $250k 5 year CD at 3%
1 x $250k 4 year CD at 2.75%
1 x $250k 2 year CD at 2.35%
1 x $250k 1 year CD at 2%

This is a lot less than buying 4 x 5year CDS but your full cash is tied up for the total period.

But at the end of year 1, you have the option of keeping the money or buying a another 5 year CD at the going rate. You will continue to having a CD coming due each year. After five years, renewing each year for a five year CD, you have a CD coming due each year but all were purchased at the then going five year rate.

 

[ShokWaveRider]

In a rising interest rate environment, your income will go up as you renew. When interest rates are falling, you lock in longer terms, as all those PenFed 3 percent five year CD holders did. The ladder approach appears to be the way to go today.

I am one of those holders.

 

[Perryinva]

Exactly the first 4 years are not maximized. Nature of the beast. I am not advocating this as a great strategy, but for someone that is unwilling to invest in the market or bonds and doesn’t care if they chew in to principle because at this point in their life, they feel they would rather not lose any more than chance making more, then it minimizes the inflation risk to non lethal proportions. The net draw from principle stays fairly constant, with the rates maintaining the same relative distance from inflation. This is anecdotal and I certainly see the appeal. I know that my spouse would rather stash our nest egg that way raher than invest it. She knows we don’t need it to live, so in her mind, there is no need to maximize gain with risk. Let’s keep it for out of ordinary expenses and ALWAYS know its there “growing”. In my mind, we don’t need it to live on, so it CAN carry some risk, as we will never need a large percentage of it for anything in the near future. I feel confident that say a 60/40 has a higher average upside return over the next 15 year time frame, like most here do. I mean, that’s HOW it got this size. I don’t have any references that track average 5 year CDs vs inflation bit I’m sure the data is out there. I wouldn’t advocate all of it invested 60/40 as old age really approaches, but at 62 to 75 at least, makes sense to me.

 

[eytonxav]

40% is in 401k & 427b with taxes due upon withdrawal. Our ages are 65 & 60 respectively.

I have calculated if we did this it would last us for ~40 years with a 1.5% annual increase.

Did you include the impact of RMDs on your before tax $s in that 40 year estimate?

 

[me228]

Used cd's

I

The key, IMO is that you never want to buy a "used" CD

Why not buy secondary market cd's as long as you don't buy at a premium? They are still FDIC insured? Am I missing something?