Gyroscopic Investing

Related to my last post. Convince me to something other than put my money in 5 year CDs at Barclays, please. Currently cash earning .9% at American Express Savings. Have other cash elsewhere, so unlikely I will need this for a year or more.

I recently opened a new 5-yr CD at Barclay's so have no alternatives to convince you of.  Curious to hear other suggestions as well (but you're not alone at Barclays!)

Had it not been for MachineGhost's post elsewhere, I'd actually have no idea that you can get out of these early and still do better than most other investments. Thanks!

Is this a better option than $5,000 in ibonds?

MediumTex wrote: Is this a better option than $5,000 in ibonds?

No. But maxed on iBonds with 10k via TD and 5k via refund on taxes.
Looking for another place for deep cash. Thanks for helping.

BearBones wrote:

MediumTex wrote: Is this a better option than $5,000 in ibonds?

No. But maxed on iBonds with 10k via TD and 5k via refund on taxes.
Looking for another place for deep cash. Thanks for helping.

I think that any CD is good for part of your cash if the rate is 1-2% higher than t-bills.

Considering that the 5-yr CD at Barclays is 2.25%, while the current 5-yr treasury is 1.25%:

Risks/rewards for the holder of the treasury bond:
If rates rise, you will have capital losses.
If rates drop, you will make capital gains.
If rates stay the same, you will still get capital gains from 'riding the yield curve'.
Interest from the treasury is exempt from state income taxes.

Risks/rewards for the holder of the CD:
No capital gains/losses with the CD, but if yields go up a lot, you could cash in your CD and buy a fresh one, losing about 6-months of interest.
Risk of FDIC not making good on their promise.  Even in 2008, when lots of banks failed, this did not turn into a real-world problem.

So, what is the conclusion?  Today, it costs about 1% to hold the treasury bond instead of the Barclays CD.  Is it worth 1% to you to avoid the FDIC and banks in general?  WWHD?  (what would Harry do?)

I think Harry had lived through enough times to just go with the treasury and be done with it.  You never know when the next banking crisis is right around the corner.  Over the past few years, the rate difference between the treasury and the CD was lower, and there have been capital gains from riding the yield curve, making the treasuries the better/safer option.  Today the situation has reversed, but it may reverse back again at any time.

We have been brainwashed by the last few years of low interest rates.  Imagine if you went into a coma in 1980 when yields were much higher, and you woke up today faced with this decision: 1.25% for the ultra-safe treasury or 2.25% for the bank product.  From that perspective, it is a no-brainer to just buy the treasury, since the rates are so low anyways.

Austen Heller wrote: If rates stay the same, you will still get capital gains from 'riding the yield curve'.

Nice analysis. Thanks. Can you explain this?

BearBones wrote:

Austen Heller wrote: If rates stay the same, you will still get capital gains from 'riding the yield curve'.

Nice analysis. Thanks. Can you explain this?

Basically, if you buy a 5-year treasury bond, and there is an upwardly-sloping yield curve (like we have today), then this bond will have a yield that is above the market rate as it approaches maturity, which means that the bond's price will increase.

Here's a concrete example, using today's rates:
You buy a 5-year treasury bond today with a yield of 1.25%, price (par value) = 100.
After 4 years, your bond now only has 1 year until maturity.  Your bond yields 1.25%, but brand-new 1-year bonds are being issued with a yield of 0.5%.  What does this mean for your bond?  The treasury market has re-priced your bond, giving you a yield-to-maturity of 0.5%, just like the new 1-year bonds.  The market did this by increasing the price of your bond to 100.75.  Your bond increased in value from 'riding the yield curve'.

At this point, you can take your 100.75, walking away with 0.75 in capital gains + your 100 original bond value. Or you can hold on for that last year, and walk away with 1.25 in interest + your 100 original bond par value.  Your tax situation might influence your decision.  Riding the yield curve only has benefits if you sell your bond before it matures.  If you hold it all the way to maturity, then any capital gains are lost, since the final bond price will always be 100.

This example assumes that the yield curve was static during your ownership, which of course is a BIG assumption, but it nevertheless is a real phenomenon that can increase your overall return from these bonds.  Riding the yield curve is most effective if you buy a bond at the steepest part of the curve.

Thanks, Austen. I take notes from the better things I see posted here, and I am saving that one. Nicely explained.

Thank you Austen!  I just learned something useful.  May I also point out that in the event of rising rates, the tax benefit you get from claiming the Treasury's capital loss means that you might do no worse than selling the CD and sacrificing 6 months of interest, unless rates really skyrocket.  In which case your gold gains will more than make up the loss.

I wish it were otherwise, but my state/local tax situation just about wipes out the advantage of the CD.  I pay more than half my federal tax in state/local.  Ouch.

sophie wrote: Thank you Austen!  I just learned something useful.  May I also point out that in the event of rising rates, the tax benefit you get from claiming the Treasury's capital loss means that you might do no worse than selling the CD and sacrificing 6 months of interest, unless rates really skyrocket.  In which case your gold gains will more than make up the loss.

I wish it were otherwise, but my state/local tax situation just about wipes out the advantage of the CD.  I pay more than half my federal tax in state/local.  Ouch.

I hear you.  NYC really lays the taxes on thick.  I am also in a high-tax area (CA).  If you invest only in an IRA, then CDs might make more sense, but in a taxable account, the advantages of the CD over the treasury bond start to slip away.  Just a few months ago, the yield spread between the 5-yr CD and the treasury was only about 0.5%, making the treasury the easy choice for a taxable account.  The spreads have widened, but the treasuries can still make sense.  A hybrid approach is also reasonable.