Investing in 10-Year CDs

I originally wrote this in July 2007. A lot has changed, but in general the reasoning is still sound. Please note that now is probably not the time to buy a 10-year CD unless it has a 6-month or lower early withdrawal penalty. But that is my opinion you are free to make up your own mind.

Some Reasons for doing so:

I want a stable, decent rate of return.

What is a decent return? Since 1995, the 15-year average rate on 3-month T-Bills has been 3.42%. For 6-months, it has been 3.51%. When I first wrote this I went back to 1992 and the averages were 3.86% and 3.97%. A couple of years of historic lows does change the picture a little.

Our database goes back to 1993. The weighted-average 1-year rate as of 2/28/10 was 4.33%. The average 5-year was 4.479%. So right now, with the 10-year hovering around 4.00%, you'll probably fall short of what you could earn. But it may not be too long before the rates are in range.

I have a well balanced and laddered portfolio.

This still holds true. However, finding a 10-year with a penalty that isn't too high just adds some icing to the cake. If you don't have all of your eggs in one basket that is a good sign. What the various baskets are, is based on your risk tolerance, goals, age, etc. When it comes to laddered portfolios, if you have funds coming due in the next 1-year, 2-year, 3-year, etc. you are well protected on that front. If rates go up, you can take advantage of those as your funds become available. If rates go down or hold, you have some funds on the longer end that are protected with a nice rate. But trying to time things is very difficult. Historical information is just good as a guide; it provides no guarantees of what the future will hold. Maintaining a good ladder allows you to do longer-term CDs at times. The average 5-year CD portfolio pays about 1.00% over an average 1-year CD portfolio.

Some Reasons for not doing so:

This is the only money I have.

Putting all of your money in any one investment vehicle isn't prudent. So if $100,000 is all you have, putting it in a 10-year CD wouldn't be advisable. If you are in your later years, and principal preservation is your goal, taking that $100,000 and putting some in savings to cover emergency needs and then ladder the rest would be a good plan.

I'll be buying a house, sending children to college, etc.

When is the big question here. If you plan on having any major expenses in the next 10-years, and you don't have a very high reasonable expectation of having other means to cover them, don't do a 10-year CD. Most longer-term CDs have a large penalty to close early and you don't want to be in a situation where you have to break the CD. But, try to strategize (on the conservative side) when you will need the funds. Then ladder your investments out across different maturities. When each maturity comes up, reassess to see if you can maintain the maximum term you have set-up.

For instance, you set-up a ladder that has funds coming due every 6-months and the longest maturity is in two years. When the first funds become available, determine when you will need them. If the funds will be needed in the very near future, move them to a high yielding savings account, if not invest in the term that fits your situation, eg., a 1-year, 2-year or even longer term CD.

Another thing to remember is don't try to be greedy. It is impossible to predict when any rate cycle (up or down) will change. If the rates are in range or slightly better than historic averages, It may be a good idea to lock them in.

Chris Duncan is a FINRA Registered Representative. He specializes in helping clients find the best and highest CD rates nationwide. His clients include individuals, financial institutions, corporations, and public agencies. Visit us for more Certificate of Deposit info.

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