Should You Switch Your Bond Portfolio to CDs?
With interest rates rising for saving accounts and certificates of deposit (CDs), I’ve had a few questions on whether or not CDs should take the place of bonds in a portfolio. After all, you can earn nearly the same interest rate on a 1-year CD (4.15%) as a 2-year Treasury (4.18%) as of January 19th.
Capital One 1-year CD rate (1/19/2023)
After a horrible year for bonds in 2022, this question makes sense if you could get a similar interest rate without all the volatility.
I think CDs make sense for short-term expenses that are expected to be paid within a year, or for investors slowly dollar-cost averaging into the market. It serves as a stable place to stash cash that will be needed soon.
However, I don’t think they should replace the entire bond portion of a long-term investor’s portfolio. If you are a long-term holder of bonds and coming off the worst year in decades, it makes sense to continue to own them and expose yourself to the potential upside. Just recently, the aggregate bond index rallied nearly 7% since November 1st.
As unexpected as this move was, it gives you an idea of how quickly an asset class can bounce back after a downturn. If you had decided to move out of bonds for a short period of time to avoid volatility, you would have missed the best kind of volatility – a move up!
If you are a long-term investor, I think you can benefit from bond exposure in up, down, and sideways markets.
If rates rise, bond prices will mostly decrease. However, most bond funds will continue to buy the new bonds at the now higher rates, and you will benefit from those higher rates over time.
If rates fall, your bond portfolio will mostly increase as your bonds with higher rates will look attractive in a market with lower rates.
And if rates go nowhere, you can lock in higher rates for longer in the bond market. While most CDs are limited to 1-5 years, a bond portfolio can lock in higher rates for 5-10+ years, providing a predictable income stream for longer.
Happy Planning,
Alex
This blog post is not advice. Please read disclaimers.