I was listening to NPR’s Marketplace last night, a story about the gentrification of a Los Angeles neighborhood. And then came this quote from Steve Jones, the owner of a house-flipping business, on how he attracts investors:
“All these people out there that have so much money, it’s sitting in a stupid money-market account making, you know, 2 percent or 3 percent, or whatever their horrible rates are right now …”
Steve Jones may know a lot about house-flipping, but he certainly knows nothing about investing in a money-market account. Fidelity’s main general-purpose money market account is yielding 0.01%, as is Vanguard’s Prime Money Market account. This has been true for more than six years. Vanguard’s fund has returned 0.04% annually over the last five years, and only 1.67% over the last 10 years.
So when someone calls 2% or 3% returns ‘horrible’ …. well, I would say those returns look pretty desirable, and almost impossible to find today in a super-safe investment.
A year ago, I wrote about a great 5-year CD offered by the Pentagon Federal Credit Union, paying 3.04%. It was offered only in December 2013 and January 2014; I speculated it was designed to draw new customers. It worked for me, and I jumped aboard.
I also have a set of 5-year CDs paying 3.0% from my local credit union, Truliant. These mature in various months of 2015. This was also part of a ‘special offer’ and well above market rates of 2010.
But, here we are in December 2014, and these are the rates being offered for Treasurys and non-jumbo CDs (the jumbos pay just slightly higher):
- 0.01% Vanguard Prime Money Market
- 0.14% 1-year Treasury
- 0.26% National average 1-year CD
- 0.30% Truliant 1-year CD
- 0.80% Penfed 1-year CD
- 0.84% National average 5-year CD
- 1.00% Ally Bank 1-year CD
- 1.20% Penfed 5-year CD
- 1.40% Truliant 5-year CD
- 1.69% 5-year Treasury
- 2.32% Nationwide Bank 5-year CD
Just as a side note — it’s outrageous that a 5-year Treasury is out-yielding most 5-year bank CDs. There are no state income taxes on Treasurys, and these low rates indicate banks and credit unions are not making any attempt to sell 5-year CDs.
Now, let’s assume that inflation averages 2.0% over the next five years. My feeling is that this is a low number, but inflation has been very muted in recent years, so let’s go with 2.0%. Here are the ‘real’ returns – after inflation – for those investments:
- – 1.99% Vanguard Prime Money Market
- -1.86% 1-year Treasury
- -1.74% National average 1-year CD
- -1.70% Truliant 1-year CD
- -1.20% Penfed 1-year CD
- -1.16% National average 5-year CD
- -1.00% Ally Bank 1-year CD
- -0.80% Penfed 5-year CD
- -0.60% Truliant 5-year CD
- -0.31% 5 year-Treasury
- 0.32% Nationwide Bank 5-year CD
Let’s compare this to I Bonds and TIPS. I Bonds purchased through April 30, 2015, will carry a fixed rate of 0.0%. This means they have a real return of 0.0% – and while that sounds bad, it makes I Bonds better than all the investment options on the above list, other than the Nationwide offering.
A five-year TIPS is currently yielding 0.21%. This translates to a real return of 0.21% – better than every investment on our list except for the Nationwide CD.
In addition, TIPS and I Bonds offer ‘inflation protection.’ If inflation rises to unexpected levels, the effective return on these investments also rises. You’re covered – and that is valuable insurance for investors.
A year ago, a 5-year TIPS was yielding -0.17%, 38 basis points lower than it is today. A 5-year Penfed CD was yielding 3.0%, 180 basis points higher than it is today. That is a massive swing – 218 basis points! – in favor of TIPS.
Last year, I argued that a 5-year CD was a better investment than a 5-year TIPS and at least competitive with I Bonds, which were then yielding 0.2% above inflation.
That’s no longer true as we approach 2015.