Should I Stay with CDs or Invest?




Ask SmallInvy

Hi, SmallIvy
 
What are your considerations for a 2 year CD that is about to mature?  The CD is about $7000, and this money is slated for after age 65 retirement years.  At this time, renew the CD or take the proceeds and invest them?  The time horizon is about 15 years. 

Thanks,

 C

Dear C,

I avoid providing specific investment advice since that would fall within the scope of the financial advisor.  I can however, provide some information and some options.

Please see the long-term chart of the DJIA, located at:   http://stockcharts.com/charts/historical/djia1900.html.

In the history of the markets, most 5-year periods have shown a net positive gain and virtually every 10-year period has shown a gain.  The notable exception was the crash of 1929, after which it took about 25 years to regain the old peak.  (Note also that there were a lot of jumps and dips along the way.)  However, putting a large sum into the market at one time and holding has proven to be far less successful than buying in increments.  Note in the 1900’s, the 30’s and 40’s, the 60’s and 70’s, and the 2000’s there were many points where if you dumped everything into the markets and waited, you’d come out flat after a 5-10 year period, and sometimes even lose a little.

Despite comparisons to the Great Depression, the 2000’s have looked a lot more like the period in the 1960’s and 1970’s than the 1930’s.  The markets have gone through fits and starts, there have been troubles at the banks causing a government bailout (compare to the S&L bailout).  There has even been gas shortages, high-priced oil, and Islamic Revolutions in the Middle East.  On the economic side, the most important factor has been a Fed which has been printing money like mad, actually trying to spur inflation to pick the economy up.  While the “Core Inflation” rate which the Fed watches has shown little change, food prices, energy prices, and precious prices have seen a surge.  Because the Core Inflation rate takes into account house prices, which have been falling from bubble prices, and does not take into account energy and food, which have been soaring, inflation may in fact be worse than the Fed believes.

In inflationary times, to be locked into CDs for any period of time is not desirable.  Your $7000 may have an equivalent value of $4000 or less in 15 years if you leave it in a CD, particularly if you buy longer term CDs and inflation picks up after you have already locked in the rate.  Stocks will fall initially after inflation sets in, but eventually the companies will be able to pass the higher prices along to consumers and the value (in dollar terms) of the company assets will increase.  They therefore make good inflation hedges – better even than gold since gold pays no dividend and is subject to speculative bubbles.

If one has money that is to be left untouched for many years, the best thing would therefore be to put that money into stocks (in mutual funds if one is not able to/does not wish to pick stocks).  Also, buying in over a period of time, maybe 2 years, rather than dumping the whole sum in at once, would be best to avoid buying at a peak.  The larger the sum one has to invest, the more this process should be spread out.  One could just pick some specific increment to invest the money (maybe the third Thursday of every third month)  or one could choose to buy based on market activity (for example, buy another increment each time the market declines by 5%).  The second strategy might lead to slightly better gains but takes a bit more monitoring of the markets.  Luckily, the internet has made this a lot easier.

Once one has bought in fully, one would sit on the position until within about 10 years of needing the money.  Once one and has gotten within 10 years of needing the money, the risk of a market drop reducing the amount available grows.  One should therefore start looking for a good exit point to start moving funds back into cash/CDs. Realizing that the value of shares will rise and fall, one would want to pull money out if prices are reasonably high.  What constitutes “reasonably high” may be based on historical returns (for example, if the return on one’s investment was about 15%-20% per year, that would be a good exit point).  Another criteria might be the balance relative to what is needed.  If there is enough in the account to cover needed expenses, why wait and take the chance that the balance may fall below what is needed. 

To ask a question, email  vtsioriginal@yahoo.com or leave the question in a comment.

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Disclaimer: This blog is not meant to give financial planning advice, it gives general information on wealth building, securities, investment strategies, and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not, who knows the whole financial picture of the individual.  Any tax information discussed is what the author believes to be true but may not be correct.  Consult a CPA for tax advice.   All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

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