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-Year). 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 term protects against the ups and downs that are coming.
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