Common sense and Bonds vs CDs
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Subject Author Date
Common sense and Bonds vs CDs Robert Ricks 01-19-2007
Posted by Robert Ricks on January 19, 2007, 7:59 pm
I posted this question over a year ago and was encouraged by many to
purchase bonds because "bonds should be part of ones portfolio."

Let me try again with some data.

What logic is there in buying bonds over CD's?

For example: I just checked Schwab and they list 5 year bonds of AAA to A
quality from 5.15 - 5.79. Of course, when most of us buy one (I've never
purchased one, however), there is the brokerage fee. (And probably the same
if we were to sell early). So, the percent I take home with me is really
less than what is shown after fees, if the bond is held to maturity. - and
if it isn't called, or if the company doesn't hit a streak of bad luck and
go belly up. In other words, there is some risk and no 100% guarantee the
coupons will be paid or the company will not have problems affecting the
return of principle.

On the other hand, I can buy a 5 year CD without any fee paying 5.30%
interest (actually higher than many bonds, with FDIC insurance and 100%
certain I have nothing to worry about (other than the US falling apart, in
which case bonds would likely be in worse shape).

Am I missing something here? Why would I want to own bonds that do carry
risk when I can get a sure thing with 100% safety? "Because every portfolio
(or most-not trying to argue minor technicalities here) should contain
bonds" doesn't seem logical. 2+2=3? What am I misunderstanding?

Steve



Posted by PeterL on January 19, 2007, 8:03 pm

Robert Ricks wrote:
> I posted this question over a year ago and was encouraged by many to
> purchase bonds because "bonds should be part of ones portfolio."
>
> Let me try again with some data.
>
> What logic is there in buying bonds over CD's?

You are not missing a thing. Bonds are more liquid than CD's.


>
> For example: I just checked Schwab and they list 5 year bonds of AAA to A
> quality from 5.15 - 5.79. Of course, when most of us buy one (I've never
> purchased one, however), there is the brokerage fee. (And probably the same
> if we were to sell early). So, the percent I take home with me is really
> less than what is shown after fees, if the bond is held to maturity. - and
> if it isn't called, or if the company doesn't hit a streak of bad luck and
> go belly up. In other words, there is some risk and no 100% guarantee the
> coupons will be paid or the company will not have problems affecting the
> return of principle.
>
> On the other hand, I can buy a 5 year CD without any fee paying 5.30%
> interest (actually higher than many bonds, with FDIC insurance and 100%
> certain I have nothing to worry about (other than the US falling apart, in
> which case bonds would likely be in worse shape).
>
> Am I missing something here? Why would I want to own bonds that do carry
> risk when I can get a sure thing with 100% safety? "Because every portfolio
> (or most-not trying to argue minor technicalities here) should contain
> bonds" doesn't seem logical. 2+2=3? What am I misunderstanding?
>
> Steve


Posted by Steven L. on January 19, 2007, 8:59 pm
Robert Ricks wrote:
> I posted this question over a year ago and was encouraged by many to
> purchase bonds because "bonds should be part of ones portfolio."
>
> Let me try again with some data.
>
> What logic is there in buying bonds over CD's?
>
> For example: I just checked Schwab and they list 5 year bonds of AAA to A
> quality from 5.15 - 5.79.....Of course, when most of us buy one (I've never
>
> On the other hand, I can buy a 5 year CD without any fee paying 5.30%
> interest....
> Am I missing something here?

Yes, you are missing something: The difference between the yield on
bonds vs. the yield on CD's (part of the so-called "yield curve")
fluctuates over time.

Right now, we're in a so-called "inverted yield curve"--with the Fed's
current anti-inflation policy, short-term interest rates have risen to
the point that they are actually higher than some long-term interest
rates. Therefore right now, 6 month bank CDs are offering a yield as
good as what you can get with much longer-term bonds. But that type of
yield curve is unusual.

Back in 2002, when the Fed was lowering short-term interest rates to
keep the economy from tipping into a recession after the 9-11 terrorist
attack, bank CDs were paying extremely low interest rates (like 2%), and
longer-term bonds were actually offering a yield advantage.

You can look at how the yield curve fluctuates over time here:

http://stockcharts.com/charts/YieldCurve.html

So it's a question of timing. You are better off buying bonds when
their yield is significantly more attractive than what you get with
short-term CDs. That's not the case right now. But it was the case 3
years ago and one day it will be the case again.


--
Steven D. Litvintchouk
Email: sdlitvin@earthlinkNOSPAM.net
Remove the NOSPAM before replying to me.

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