Are CDs The Right Investment Today?
Everyone is talking about safety these days and many people are looking to money markets (now that the Fed is behind them), Treasury Bills and CDs for the safety they crave. These have become the investments of choice for many of the fearful. I have even seen statistics showing a large increase in the sales of in-home safes (I suppose it’s today’s equivalent of putting your money under the mattress) as people run for cover when the markets go down. When things are good, they start following the crowd once again and reach too far for investment return. I’m sorry to say I have seen this reaction time and time again in my 28 years. Why does this happen? In my view, it’s the way many understand the term “risk”. There are different types of risk and investors tend to focus on the wrong type. Here’s what I mean.
What if you needed to go from New York to LA and wanted to do it in the fastest, safest way? What would you do: Would you fly? Take a train? Drive? Without delving into statistics and with a little Google research, I’ve discovered what most people know; flying is the safest, fastest, followed by train followed by car.
Now let’s talk fear and perception. When you get into your car, all four wheels are on the ground, you’re in control surrounded by a seat belt and air bags to boot! You FEEL relatively safe. There is no turbulence and you point the car and go. You feel safe and you are willing to give up getting to LA quickly, with the notion that you will get there more safely.
When flying, you have the same seat belt (a lot of good it would do!) and a huge machine under you pulling 120,000 tons of weight into the air. You may feel nervous at take off, I know I do, and the flight may contain numerous bumps and ups and downs as the plane adjusts to atmospheric conditions. You may even feel a little air sick because of the turbulence. And yet…it’s the fastest and statistically the safest mode of transport.
How do we define safety? Is it the turbulence you experience? Or is it the fear you feel because of it? Shouldn’t it be the ultimate goal of getting to your destination safely? No one thinks air travel is safe because there is no turbulence; it’s safe because more people arrive safely per mile travelled.
When you look at the two modes of transportation, by air or by car, air travel wins by a large margin. It’s much safer and much faster than driving.
What does this have to do with investing? I bet you’re a little ahead of me. The question is: What is the fastest and safest way to get to your financial destination? Is it CDs? Stocks? Bonds? Real Estate? Gold?
Here’s my take on it… Let’s start with the fastest mode and use the Rule of 72 to calculate speed. The Rule of 72 states that to find out how long it will take for your money will double, divide the rate of return you receive into 72. For example, a 10% return, will double your money in 7.2 years. At 5%, your money will double in 14.4 years. Simple, right?
Looking at today’s CDs, we find current rates to be about 4.5%. At a 4.5% rate, your money will double in 16 years. If we take taxes into account, the doubling time is 20 years. A very long time, right? Fast or not fast? Not fast. What about the ride? Volatile or smooth as silk? Smoooth…..Is this best for your financial help because of the lack of turbulence? I would argue no. 4.5% net of taxes is about 3.5%. If you consider a reduction in your standard of living a serious risk, you must take inflation into account. If inflation is 3%, then you are left with little if any left over to take income or any other benefits from your savings. This is a greater risk.
What about stocks? These days the turbulence is breathtaking and not a little nauseating. Down 400 points on a Wednesday up 557 points on Thursday, and no one knows what it’s going to do on any given day. In terms of safety, if you are trading this mess, it’s extremely risky. If you own a diversified portfolio that you don’t need to touch for 5 to 10 years, history has shown that the volatility of stocks over a long term diminishes. But today there is even more. Now when everyone is travelling “by-land”, meaning they are rushing to CDs in order to avoid the turbulence, current prices are indicating that stock investment returns for the next 10 years could be 10%-12%. Why do you think he’s buying along with so many other successful value investors?
Recently I read the weekly report from John Hussman. He is the money manager of the Hussman Funds. (www.hussmanfunds.com) and has been bearish as long as I can remember. His management style enables him to buy stocks and hedge them at the same time with various financial instruments. He has been hedged all year and his fund has held up very well. In his most recent column, which can be found at his web site (www.hussmanfunds.com), John wrote that based on the current value of US stocks, and using normalized earnings projections going forward, he expects stocks to earn 10-12% over the next 10 years. Yes, this is prediction like so many others (everyone has an opinion don’t they?), but at the very least, his is based on level-headed, established mathematics and proven experience in the real world. Not on emotion, hearsay or the desire to sell you a quick road to riches. He also says that volatility (read turbulence) is going to be high. So he’s still keeping part of his hedges.
A 10% return means 7.2 years to double. 12% is 6 years. These are predictions, not guarantees or facts, but I think it’s high quality information to help guide you forward.
Decent quality Corporate Bonds are yielding 6% to 8% these days. Some volatility, some uncertainty, but in my opinion, definitely a rate of return which pays you for these attributes. 6% doubles in 12 years, 8% in 9 years.
So the point is: are CDs the fastest and safest? Not even slightly, in my opinion. Not the fastest, nor (relative to inflation), the safest.
Stocks are fastest and if we define risk as the probability of reaching your destination in 10 years, the safest.
Bonds are faster than CDs. And (inflation adjusted) safer. —More like taking the train.
So what do you think? Are you ready to take be more courageous by not allowing the turbulence to dissuade you from getting to your destination with a higher probability of a safe arrival? Or are you going to be lured into the seeming coziness of your comfy car thinking your safe arrival is assured (when statistically, it’s not)?
I guess it depends how you define safety. I know how I define it, how about you?
Are CDs The Right Investment Today?
Everyone is talking about safety these days and many people are looking to money markets (now that the Fed is behind them), Treasury Bills and CDs for the safety they crave. These have become the investments of choice for many of the fearful. I have even seen statistics showing a large increase in the sales of in-home safes (I suppose it’s today’s equivalent of putting your money under the mattress) as people run for cover when the markets go down. When things are good, they start following the crowd once again and reach too far for investment return. I’m sorry to say I have seen this reaction time and time again in my 28 years. Why does this happen? In my view, it’s the way many understand the term “risk”. There are different types of risk and investors tend to focus on the wrong type. Here’s what I mean.
What if you needed to go from New York to LA and wanted to do it in the fastest, safest way? What would you do: Would you fly? Take a train? Drive? Without delving into statistics and with a little Google research, I’ve discovered what most people know; flying is the safest, fastest, followed by train followed by car.
Now let’s talk fear and perception. When you get into your car, all four wheels are on the ground, you’re in control surrounded by a seat belt and air bags to boot! You FEEL relatively safe. There is no turbulence and you point the car and go. You feel safe and you are willing to give up getting to LA quickly, with the notion that you will get there more safely.
When flying, you have the same seat belt (a lot of good it would do!) and a huge machine under you pulling 120,000 tons of weight into the air. You may feel nervous at take off, I know I do, and the flight may contain numerous bumps and ups and downs as the plane adjusts to atmospheric conditions. You may even feel a little air sick because of the turbulence. And yet…it’s the fastest and statistically the safest mode of transport.
How do we define safety? Is it the turbulence you experience? Or is it the fear you feel because of it? Shouldn’t it be the ultimate goal of getting to your destination safely? No one thinks air travel is safe because there is no turbulence; it’s safe because more people arrive safely per mile travelled.
When you look at the two modes of transportation, by air or by car, air travel wins by a large margin. It’s much safer and much faster than driving.
What does this have to do with investing? I bet you’re a little ahead of me. The question is: What is the fastest and safest way to get to your financial destination? Is it CDs? Stocks? Bonds? Real Estate? Gold?
Here’s my take on it… Let’s start with the fastest mode and use the Rule of 72 to calculate speed. The Rule of 72 states that to find out how long it will take for your money will double, divide the rate of return you receive into 72. For example, a 10% return, will double your money in 7.2 years. At 5%, your money will double in 14.4 years. Simple, right?
Looking at today’s CDs, we find current rates to be about 4.5%. At a 4.5% rate, your money will double in 16 years. If we take taxes into account, the doubling time is 20 years. A very long time, right? Fast or not fast? Not fast. What about the ride? Volatile or smooth as silk? Smoooth…..Is this best for your financial help because of the lack of turbulence? I would argue no. 4.5% net of taxes is about 3.5%. If you consider a reduction in your standard of living a serious risk, you must take inflation into account. If inflation is 3%, then you are left with little if any left over to take income or any other benefits from your savings. This is a greater risk.
What about stocks? These days the turbulence is breathtaking and not a little nauseating. Down 400 points on a Wednesday up 557 points on Thursday, and no one knows what it’s going to do on any given day. In terms of safety, if you are trading this mess, it’s extremely risky. If you own a diversified portfolio that you don’t need to touch for 5 to 10 years, history has shown that the volatility of stocks over a long term diminishes. But today there is even more. Now when everyone is travelling “by-land”, meaning they are rushing to CDs in order to avoid the turbulence, current prices are indicating that stock investment returns for the next 10 years could be 10%-12%. Why do you think he’s buying along with so many other successful value investors?
Recently I read the weekly report from John Hussman. He is the money manager of the Hussman Funds. (www.hussmanfunds.com) and has been bearish as long as I can remember. His management style enables him to buy stocks and hedge them at the same time with various financial instruments. He has been hedged all year and his fund has held up very well. In his most recent column, which can be found at his web site (www.hussmanfunds.com), John wrote that based on the current value of US stocks, and using normalized earnings projections going forward, he expects stocks to earn 10-12% over the next 10 years. Yes, this is prediction like so many others (everyone has an opinion don’t they?), but at the very least, his is based on level-headed, established mathematics and proven experience in the real world. Not on emotion, hearsay or the desire to sell you a quick road to riches. He also says that volatility (read turbulence) is going to be high. So he’s still keeping part of his hedges.
A 10% return means 7.2 years to double. 12% is 6 years. These are predictions, not guarantees or facts, but I think it’s high quality information to help guide you forward.
Decent quality Corporate Bonds are yielding 6% to 8% these days. Some volatility, some uncertainty, but in my opinion, definitely a rate of return which pays you for these attributes. 6% doubles in 12 years, 8% in 9 years.
So the point is: are CDs the fastest and safest? Not even slightly, in my opinion. Not the fastest, nor (relative to inflation), the safest.
Stocks are fastest and if we define risk as the probability of reaching your destination in 10 years, the safest.
Bonds are faster than CDs. And (inflation adjusted) safer. —More like taking the train.
So what do you think? Are you ready to take be more courageous by not allowing the turbulence to dissuade you from getting to your destination with a higher probability of a safe arrival? Or are you going to be lured into the seeming coziness of your comfy car thinking your safe arrival is assured (when statistically, it’s not)?
I guess it depends how you define safety. I know how I define it, how about you?
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Posted in On The Money! Commentary