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Putting CDs to Work in a Mutual Fund Portfolio

A reader writes in, asking:

“You linked recently to an article saying long-term CDs are now a better option than bonds altogether. How do you feel about that? Part of my problem here is that my cash reserves are not very large (about 1.5% of my total assets), and also there’s no way to rebalance within a Vanguard IRA into CDs.”

I do think CDs are relatively attractive right now. For example, Ally’s 5-year CD has roughly twice the yield of Admiral shares of Vanguard’s intermediate-term Treasury fund, despite the fact that the Ally CD has less interest rate risk and (assuming you stay under FDIC limits) the same credit risk. And if you shop around, you might even be able to find a CD that’s better than Ally’s.

You Can Do a Partial Account Transfer

The two issues that people run into when trying to figure out how to use bank (or credit union) CDs in a mutual fund portfolio are that:

  1. Banks don’t offer any good options as far as stock holdings (so you don’t want to move everything to the bank), and
  2. It’s impossible to rebalance with CDs.

Fortunately, neither of these is a problem given that you can do a partial account transfer, even with an IRA. That is, you can keep your current IRA and simply do a direct trustee-to-trustee transfer, moving a portion of the money into a new IRA with the bank or credit union.

For instance, if you decide that CDs offer a good risk/reward ratio, you might choose to transfer an amount equal to just half of your fixed income allocation. This way your stock holdings would be unaffected, and you would still have some traditional bond fund holdings with which you can easily rebalance.

CDs Are More Work

But moving money from one custodian to another does require some effort. And, depending on what happens with interest rates down the line, you might end up wanting to move it back — or to yet another custodian. And even if you leave the money at one bank/credit union, there’s a bit of ongoing work involved in buying new CDs when the current ones mature.

So it’s a question of whether the additional yield is worth the additional effort. (Admittedly, when given the choice between two options, I tend to go with the lazier approach with my own portfolio.) There’s no right answer here. It will depend on:

  • Your personal tolerance for administrative hassle, and
  • The size of your fixed income allocation (the larger the allocation, the greater the dollar value of the additional yield).

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