Viewpoints

Weathering The Storm With CDs

A generation ago, retiring clients usually had most of their money locked up in certificates of deposit at the local bank. Simplicity, predictability, and the double-digit yields of the time provided a nice compliment to Social Security or pension checks. Over the last couple of decades, though, falling interest rates and a rising stock market have diminished the allure of CDs, especially for retirees.

A generation ago, retiring clients usually had most of their money locked up in certificates of deposit at the local bank. Simplicity, predictability, and the double-digit yields of the time provided a nice compliment to Social Security or pension checks.

Over the last couple of decades, though, falling interest rates and a rising stock market have diminished the allure of CDs, especially for retirees. Even those who are looking for conservative sources of income have veered toward bond mutual funds, either on their own or with your help.

But the current economic climate dictates reconsideration of these once popular investing vehicles. Here are five reasons you and your older clients can get excited about “boring” certificates of deposit.

  1. PREDICTABILITY

    Clients on the cusp of retirement might already be suffering from a loss of professional identity, a change in lifestyle and social contacts, and concern over their money will last as long as they do.

    Rather than risking the odds that you'll put their assets to work in the stock market at the dawn of a bear market, they (and you) may be better served by starting out with a few short-term certificates of deposit, scheduled to mature over the next few months or years.

    By the time the CDs come due, exactly as you planned and promised, your clients should be a little more comfortable in retirement, more confident in your investment acumen, and ready to take a bit more risk in pursuit of a little higher long-term return.

  2. TRANSPARENCY

    Fixed-income mutual funds offer several advantages over individual bonds or certificates of deposit, including diversification, liquidity, and professional management of the portfolio.

    But the recent sub-prime mortgage fallout has many investors and advisors wondering just what potential disaster may loom in their managed funds (and some of the professional managers are trying to figure out what's in their respective funds, as well).

    Investors with a portfolio of CDs, however, know exactly what they have, when they will get their money back, and what they will earn while they're waiting for the principal to be returned.

  3. A “PUT” BOND?

    As you probably know, banks and credit unions typically impose a “substantial penalty for early withdrawal” if a CD owner withdraws the money before the stated maturity date. Usually the penalty is three to six months of interest.

    But this penalty is actually a small price to pay for the “floor” of protection it offers. Say a client takes out a five-year certificate of deposit at a bank paying 5-percent interest, and will incur a penalty of six months of interest if the money is taken out before maturity.

    If interest rates stay flat or fall over the next five years, the client will be best-served by letting the CD mature as scheduled. But if rates rise substantially in the meantime, she can cash out of the CD, pay the penalty, and deposit the funds in a new, higher-yielding certificate.

    In the latter scenario, the maximum loss the client would experience would be the penalty — in this case, 2.5 percent of the invested amount. That's a pittance compared to what might happen to the value of long-term bonds or bond mutual funds under the same circumstances.

    The bad news is that this feature is usually only available through traditional banks and credit unions, instead of the “brokered” CDs you offer (which early-redeemers can only sell for the market price).

    Cheer up. Pointing out this strategy allows you to demonstrate your unbiased devotion to your clients' best interests. And you still may end up with most or all of their money, if only for reason #4 …

  4. ADVANTAGE: ADVISOR

    Clients who do look elsewhere for CDs may find that the ones you offer pay a higher yield than what traditional institutions offer. Or the retirees may reason that despite the “put” option described above, they still prefer to have their money under your management.

    But the biggest reason higher-net-worth investors may choose to buy CDs from you instead of a traditional bank is that it's much easier to get FDIC insurance coverage on a portfolio in the high six-figures and above.

    FDIC insurance at a traditional savings institution is typically limited to $100,000 per individual or joint account, and $250,000 per individual retirement account. There are some ways to get larger amounts covered, but then the clients have to split the CDs into different trusts or “payable on death” accounts (more information is available at www.fdic.gov).

    Contrast that with the CDs you can offer, which allow your client to theoretically have millions upon millions of dollars insured under one account title, as long as the total CD face amounts purchased are less than $100,000 per bank or credit union.

  5. MORE NET INCOME

    Clients who prefer the predictability and transparency of individual bonds to fixed-income mutual funds may still wonder why CDs might be better than Treasuries, or tax-free municipal bonds.

    Treasuries certainly offer at least the same amount of safety as CDs, along with a similar ability to custom-tailor maturities to a particular client's exact needs. Yet the yield on Treasuries usually falls far short of what CDs pay. Recently the five-year Treasury yield was hovering around 3.5 percent, while at the same time Bankrate quoted several CDs paying over 5 percent for the same maturity.

    Tax-free bonds may provide a higher after-tax yield than certificates of deposit, but typically only for the wealthiest of retirees. Keep in mind, too, that tax-free interest is included in the formula that determines whether or not Social Security payments are taxable.

    And finally, note that even the safest municipal bonds don't quite carry the protection of CDs insured through Uncle Sam.

Loving The “Ladder”

Setting up equal amounts of CDs to mature at set intervals will help protect retirees against volatile interest rates, yet still kick off enough income to allow them to retire comfortably.

And when you perform the mundane task of calling a client to tell him that his CD has matured, you'll find out that these particular clients are even more thrilled about the return of their principal, as opposed to the return on their principal.

Writer's BIO: Kevin McKinley CFP is a Vice President-Private Wealth Management at Robert W. Baird & Co., and the author of the book Make Your Kid a Millionaire (Simon & Schuster). You can reach him at [email protected]

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