Maximize CD Rates During a Flat and Inverted Yield Curve
If you want an investment that maintains your principal,
Certificates of Deposit (CDs) are a great way to go. As with
most investments, we all hope to time the market at its highest,
but without a crystal ball that proves to be difficult. The best
advice is to create a ladder and then maintain that ladder.
The temptation in a flat or inverted yield curve environment is
to go short. However, this can be disastrous if rates drop
considerably. For instance, if you invest all of your funds in
6-month CDs because short-term rates are projected to rise your
entire portfolio may be in for a surprise if the commentators
are wrong.
Let's first assume they are right. By March, Fed Funds will be
4.75% and by May 5.00%. You can purchase a 6-Month CD today with
a rate of 4.95%. If rates hold after May, when the CD matures in
August you may be able to earn 5.20%. This could be higher if
inflation starts to be a worry and more increases come. When
August comes around, you are celebrating because your portfolio
will re-price with higher CD rates.
Okay, now if they are wrong and the economy takes a down turn.
Rates rise in March, but they hold in May. By the time August
comes around, the FOMC needs to lower rates to spur the economy
once again. As a result your portfolio re-prices lower.
However, there is any easy solution to this dilemma. Build a
laddered portfolio! Generally, CD investors are paid a premium
for opening longer-term accounts. With a normal sloped curve,
longer-term CDs (5-Year to 10-Year) generally pay 50 Basis
Points to 150 Basis Points (0.5% to 1.5%) more than shorter term
CDs (6-Month to 1-Yyear). For a $100,000 investment, this is
$500 to $1500 more a year. For $1MM, this is $5,000 to $15,000
more. And taking this out for five years, that could be $75,000
more in your pocket.
Now is a perfect time to build your ladder. You can be somewhat
confident that in the short-term rates will rise and you will
probably be able to take advantage of some higher rates. The
added bonus is that you know a 5% return over any length of time
is a good return and investing long protects against the ups and
downs that are coming.