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Be Careful Not to Rush Too Heavily Into Long-Term CDs Here

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Interest rates have collapsed over the last several weeks and that may be good news for those interested in remortgaging or buying a new property.   It is also good news for anyone considering taking out a new home equity loan or line of credit or an auto loan.

It may not be good news for your savings.   Many banks dropped their online savings rates going into the July rate cut and still others are dropping their rates now based on the assumption that the Fed is not done cutting.

We are getting a lot of notes from savers who remember well a lengthy period from 2009 to 2016 when savings rates were below 1%, and are terribly fearful that we may be heading back there.   Indeed, anyone looking at Japanese or German rates and watching the talking heads on CNBC or Bloomberg can get the feeling that there is a real paradigm shift and that interest rates are never going up.

There are still banks and credit unions that are offering online 5-year CDs over 3%.   In your local market, you may even find brick and mortar opportunities at banks and credit unions to get these kinds of rates.

Here are two reasons why you should be cautious.

First, we’ve seen a panicked move in Treasuries.   Rates may not stay this low for very long.   We could be in a completely different environment in a year or 18 months with the 10-year back over 3% and perhaps even with the Fed Funds rate back over 3%.   If that happens, you will regret having limited your liquidity by locking into a long-term CD.

Second, even if rates go back to zero, you are still going to see attractive 5-year CD offers as banks will still need to lock up long-term deposits from depositors to fill their capital needs.   From 2011 until 2015, while the Fed Funds rate was at zero and the best savings rates were below 1%, it was still always possible to find 5-year CDs at or just under 2.50%.    So, even if we see a continued complete collapse in interest rates, you will always be able to get a premium for locking in for a long period.    And, yes, there is a difference between 2.50% and 3.50%, but the difference is not a matter of life or death (especially after you calculate the net income from the CD after tax).

If you see 5-year CDs as a sort of insurance against collapsing rates, then you can go ahead and devote a small amount of your savings to provide some level of protection against falling rates (be sure to check the best rates here).  But, we’d be much more inclined to direct that energy towards one-year CDs where the rates may be slightly lower, but so is the risk of getting this wrong.


Avoid The TIAA 4-year Diversified Assets Marketsafe CD

I’ve written about TIAA’s “Marketsafe CD” products, and those issued by Everbank prior to its acquisition by TIAA.   I’ve suggested that the offering of these products violates the 1933 Securities Act, and I maintain that position.  More importantly, I have always written to advise depositors to avoid thinking of these products as CDs (they should not be called CDs), and I am doing that again here.   

The latest product purports to give depositors so-called “safe” exposure to the Brazilian Real, the Euro and gold and emerging market equities.   In this case, these assets are all priced using ETFs on a pricing date, and then measured against the price of those ETFs in 4 years.   The investor gets back their principal and the weighted appreciation, if any, at maturity.   Interestingly, the video, featuring Chris Gaffney, uses the hypothetical appreciation of 6% over 4 years which would underperform by at least half the compounded performance on a 4-year CD (where you can still earn well over 3% per year).

With its past products, TIAA and Everbank provided some rationale for tying their products together.   They represented earlier products as a play on oil currencies here and here a play on emerging market currencies here or emerging market equities here or a rise in interest rates here or here.  

I am not sure of the rationale for tying together the Brazilian Real, the Euro, gold and emerging market equities.   It now seems to be a kind of “we think you’ll like this” type of thing.  A prudent investor might look at which of these things they want to own and invest in them though the ETF directly or some other means.  For example, my own personal opinion is that while gold and the Euro might appreciate against the dollar over the coming 4 years, the Brazilian Real and the emerging market ETF could easily fall quite severely.    I would look at the gold ETFs (IAU or GLD) as one alternative, and interest-earning Euro accounts as another.

As anyone who has invested in any of TIAA’s or EverBank’s Marketsafe products knows, it just takes one nasty thing in the basket to destroy it and to leave you waiting for maturity to get your principal back.  Previously, however, TIAA damaged your wealth but did not hit you with a 1099 reporting Original Issue Discount (OID).    However, if you read the terms of the latest offering, TIAA will hit you with an OID statement for imputed interest in each of the four years that you are holding this product.   While the bank would have had an obligation under Federal Tax law to have reported OID, EverBank did not do this prior to its acquisition and the fact that they are now doing it means that their products go from a dreadful idea to a ever worse one.

Bottom line: Continue to avoid TIAA Marketsafe CDs.


Avoid Municipal Bonds For Now

Those paying taxes this month in States like New York, New Jersey and California have been hit with quite a wake up call over the last few days.

Our tax bills, as a result of the 2018 Republican tax cuts, are much higher, especially since we have lost all sorts of deductions for our state taxes.

Out of the woodwork are emerging two groups of people eager to present their solutions to making April 2020, as compared with this April, a little less painful:

  1. Real estate agents from Florida and Texas.
  2. Those pushing municipal bonds.

I have nothing bad to say about the former, and I am not going to comment about the risks and benefits of relocating to Florida or Texas (I do know that New York spends a lot of money each year checking to be sure that former NY residents have met the required criteria of residency in another state and tracking them down for past taxes where they haven’t).

Rather, I want to address the people pushing municipal bonds and municipal bond funds.    I am going to say, quite simply, that my view is that buying these instruments at this time is a terrible idea for all but the extremely wealthy.  Here are 2 reasons:

First, most people, especially now, need their liquidity and should not tie up large amounts of cash in a low interest rate environment.   One-year municipal bonds - if you can find them – in New York or California have a yield to maturity below 1.40%.   Even if you are in a 50% effective tax bracket, that is still a fully tax equivalent return of only 2.80%, and you can still get 2.80% (or better) in a 1-year CD.   Unlike municipal bonds, however, you can withdraw your money early from 1-year CDs with a reasonable early withdrawal penalty (BestCashCow recommends that you identify CDs with only three month of interest as such a penalty).   As long as you stay within FDIC and NCUA limits, your CDs bear no credit risk.   Check online CD rates here.  Check local rates at banks here and credit unions here.

Second, municipal bond interest rates are extraordinarily low.   You need to go out 30 years to find a municipal bond yielding over 3%.   As a point of comparison, I was purchasing high-quality AA New York municipals in 2009 (during the financial crisis) that were seven years in duration and were yielding over 5%.    As a general rule, I do not recommend that anyone should buy municipal bonds of more than 5 to 10 years in duration under any circumstance.   At the moment, high quality municipal bonds of those durations have tax equivalent yields that, again, do not offer significant premiums over 5-year CDs.  They also are extraordinarily  risky as they can lose tremendous value (even those of intermediate durations) should long-term rates increase.

Bottom line: Wait until you see higher long-term rates before considering municipal bonds.