This blog is focused on Treasury Inflation-Protected Securities and I Bonds, both inflation-protected investments. So you might wonder why I’ve been ‘all excited’ about a 3% 5-year CD being offered by the Pentagon Federal Credit Union through Jan. 31, 2014.
One word answer: Math.
The bigger picture is that my wife and I try to keep an asset allocation of 40% stocks and 60% bonds, with a heavy allocation of bonds in tax-deferred accounts. But that is just the ‘asset type’ allocation. In addition, I monitor our ‘inflation-protected allocation‘, which I’d like to be about 15% to 20%.
I also try to monitor our ‘asset safety allocation‘, which I have written about before, and it looks something like this:
- 10% Highest risk: International stock funds, smaller-cap stock funds
- 30% Higher risk: Total stock market funds, S&P 500 funds, etc.
- 35% Lower risk: Broadly diversified bond funds, TIPS funds, municipal bonds
- 25% No risk: TIPS, I Bonds, insured bank CDs, Treasurys held to maturity
Those numbers might vary, and in fact it has been hard to keep the no-risk category up to the desired level with yields so low. I Bonds are especially helpful, because they are tax-deferred but not in a tax-deferred account. The only problem with I Bonds is the yearly purchase cap ($10,000 per person per year, plus $5,000 possible as a tax refund.).
Everywhere you turn today you see articles warning about the dangers of bond investments. And my answer to that is: Find safety. By buying TIPS, I Bonds and insured CDs – and holding to maturity (whatever you choose for I Bonds) – you completely eliminate risk. Your principal balance is not going down.
So along comes the PenFed CD, federally insured for 5 years paying 3%. It fits into the ‘no risk’ category, it’s in the fixed-income category, it can be purchased in a tax-deferred account, and the insured limit is a lofty $250,000. But it does not offer inflation protection.
So how does it compare with a 5-year TIPS, an I Bond or a traditional Treasury? Here’s the math, with the winning investment highlighted for each inflation rate:
Conclusion: This 5-year CD, especially in a tax-deferred account, can be a nice supplement to your I Bond investment this year. And since the I Bond fixed rate of 0.2% is intact through April 30, there is no rush to buy I Bonds. The PenFed offer lasts through Jan. 31, though, so time is limited on that investment.