Q. I recently got some money for my portion of the sale of a family-owned property. I don’t need the money to cover bills or upcoming purchases, so I want to invest it for my retirement (I’m 54). However, I don’t want to take any risk so I’m thinking I’ll just buy CDs. My brother says that is short-sighted and I’m leaving a lot of money on the table. Is there a better place for my cash than a 1-year CD paying 4.8%? — Linda in Satellite Beach
A. Linda, you are asking an investment question, so most of my answer will focus on some investment issues but given your goal to use these funds for retirement, the first thing you should do is figure out what type of accounts you can use. You can’t cut a check directly to an employer retirement plan but with some planning, you can maximize the use of such accounts and others like IRAs and Roth IRAs if you’re working. Your largest investment-related costs over your lifetime are likely to be taxes and those accounts can be very useful for saving for retirement an managing taxes.
The CD you are considering should avoid the risk of loss to your principal over the one-year period. As long as you do not withdraw funds from it prior to maturity, the 4.8% of interest is guaranteed to you as well.
However, that does not mean there is no risk. There is simply no such thing as a risk-free investment because risk comes in many forms. The risk of a bank failure causing you a loss is mitigated by banking regulations and FDIC coverage but there are other risks to be aware of.
For instance, one risk that plagues CDs and other holdings with safe reputations is purchasing power risk. Inflation, even when modest, erodes the purchasing power of your investments. Some of my older clients lament that they spent more on their most recent car purchase than they spent buying their first house. Prices rise over time and the investments that maintain a stable principal value have a terrible record against inflation, especially after taxes.
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One reason for this is that when fixed products offer an attractive interest rate, those rates tend not to persist, creating reinvestment risk. There is great value in knowing that your assets will be worth 4.8% more in a year, but you have no certainty what rates will be available after that.
Interest rates can change quickly. According to the US Census Bureau, the 3-month U.S. Treasury Bill, a reasonable proxy for short-term savings vehicles with reputations for excellent principal protection, yielded an average of 4.41% in 2007. In 2008 the average yield had dropped to 1.48% and a paltry .16% in 2009.
To combat reinvestment risk, many look to holdings with longer maturities to lock in a yield for a longer period. While longer maturities reduce reinvestment risk, they increase interest rate risk. If rates rise, you are stuck earning the lower rate on what you own. This lowers the value of the holding paying the lower rate and the longer the maturity, the worse the loss in value. TLT, a fund holding U.S. Treasuries with maturities of at least 20 years, lost more than 31% of its value in 2022 as interest rates rose.
This all presents a classic trade-off. The more you want to reduce one risk, the more you must accept another type of risk. A sound approach over the long term is to avoid taking on huge amounts of any one type of risk and accept many types of risk in a reasonable proportion given your goals and circumstances by diversifying and putting money in different investments.
Dan Moisand, CFP® is a past national president of the Financial Planning Association and has been featured as one of America’s top financial planners by at least 10 financial planning publications. He can be reached atwww.moisandfitzgerald.com or 321-253-5400, ext. 101.