Why buy a 10-year CD?

November 1st, 2007

Many people out there question the logic of buying 10-year CDs. And it is smart to question. Let’s examine some historical data and pose some reasons for and against. You can then make up your own mind. As this is one of our more popular posts, I have provided some updates as of 8/23/11.

Current 10-year CD at 2.40% APY. Previous rate was 2.70%.

Below you will see that the current 10-year is below historical averages. However, keep a couple of things in mind. Rates will most likely remain low for at least two more years and the above CD only has a 1-year early withdrawal penalty. As a result, the higher rate gives you income now and it provides a reasonably priced hedge against higher rates in the future.


Reasons for investing in 10-yr CD:

I want a stable, decent rate of return.

What is a decent return? Since 1992, the 15-year average rate on 3-month T-Bills has been 3.86%. For 6-months, it has been 3.97%. For 3-month 2nd Market CDs it was 4.24% and for 6-months it was 4.34%.You can view this data and more here.

Update 8/23/11: Since 1992, average 3-month T-Bill is 3.23%, 6-month is 3.34%, 3-month CD is 3.66%, and 6-month CD is 3.77%.

Our database goes back to 1993. The average 6-month rate as of 7/31/07 was 4.401%. The average 5-year was 5.405%. So somewhat recent history would imply that a 5.70% for 10-years is decent and stable.

Update 8/23/11: As of 7/31/11, average 6-month CD rate is 3.15%. Average 5-year is 4.11%

I have a well balanced and laddered portfolio.

If you don't have all of your eggs in one basket that is a good sign. What the various baskets are, is based on your risk tolerance, goals, age, etc. When it comes to laddered portfolios, if you have funds coming due in the next 1-year, 2-year, 3-year, etc. you are well protected on that front. If rates go up, you can take advantage of those as your funds become available. If rates go down or hold, you have some funds on the longer end that are protected with a nice rate. But trying to time things is very difficult. Historical information is just good as a guide; it provides no guarantees of what the future will hold.

Reasons not to:

This is the only money I have.

Putting all of your money in any one investment vehicle isn't prudent. So if $100,000 is all you have, putting it in a 10-year CD wouldn't be advisable. If you are in your later years, and principal preservation is your goal, taking that $100,000 and putting some in savings to cover emergency needs and then ladder the rest would be a good plan. This is also similar to I'm just trying to learn to invest.

I'll be buying a house, sending children to college, etc.

When is the big question here. If you plan on having any major expenses in the next 10-years, and you don't have a very high reasonable expectation of having other means to cover them, don't do a 10-year CD. Most longer-term CDs have a large penalty to close early and you don't want to be in a situation where you have to break the CD. But, try to strategize (on the conservative side) when you will need the funds. Then ladder your best investments out across different maturities. When each maturity comes up, reassess to see if you can maintain the maximum term you have set-up.

For instance, you set-up a ladder that has funds coming due every 6-months and the longest maturity is in two years. When the first funds become available, determine when you will need them. If the funds will be needed in the very near future, move them to a high yielding savings accout, if not invest in the term that fits your situation, eg., a 1-year, 2-year or even longer term CD.

cd :O)

-- By +Chris Duncan

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