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.
Treasury Inflation-Protected Securities 
Jimbo, at these levels, if you hold to maturity that TIPS at least should return something similar to the nominal Treasury, Or, if inflation spikes, you can be smiling.
Last Friday, the 5 year Treasury (FVX) shot-up to 1.684% from Thursday’s close of 1.587. With such a large jump, I was able to pick-up some 5 year TIPS with a YTM of 0.20%. With the current inflation adjustment of 1.7%, the total yield is 1.9%. That’s not far from the 2.02% that I can get for a 4 year CD. With the inflation protection, the 4 year 4 month TIPS appear to be the better deal right now (1). The original issue of that 5 year TIPS had an adjusted price of $101.87 and a YTM of -0.213% (with a paltry coupon of 0.125%). The inflation adjusted price that I paid last week for the very same bond was $101.16 (the limit price was actually below par). I was hoping to pick-up a few more of the 5 year TIPS at the re-issue on 12/18. However, the current trend In the interest rates is going in the wrong direction for them to hold a positive YTM much longer. We’ll have to wait and see what happens over the course of the next week.
Footnotes:
1) That is, unless those pesky Saudis keep the oil prices down for the next 4 years 4 months and put the world into a permanent deflationary mode.
I’m happy I opened up the tobyhana 7 year add on 3.04% cd. As my old 3% cd’s mature, I can roll it into this one. And at the worst if rates really shoot up it is a 2 year penalty. They don’t offer that cd deal anymore, but anytime I see something like this with a put option and the option of adding on I always put int the minimum to have the option.
Mike, I am also seeing that, but I think it is a bit hard to believe. I don’t doubt the Treasury has great data, though. This is a trustworthy measure. For those wondering, here is the link: http://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=realyield
That would indicate to me that the market is 1) pricing in very low inflation for the next 5 years, plus 2) starting to price in the likelihood of a Fed interest rate increase for short-term rates. The nominal 5-year Treasury has risen to 1.67% from 1.52% on Dec. 1, a nice bump but not as sharp an increase.
This is setting up for a very interesting 5-year TIPS reopening on Dec. 18. Wooo! I am getting excited!
Oops. I meant an increase of 30 bps in one week….still, a huge move.
The Treasury is reporting that the real yield curve rate for 5 year TIPS is up to 43 bps–that’s a reported increase of 40 bps in one week. What’s behind that huge move in the 5 year? Isn’t their a re-issuance of the 5 year this week? Seems like a great deal on a five year fixed income instrument.
Dave,
(I did this for you in the past, but have not now found it.)
Inflation insurance may be extremely valuable!
The 12 mo moving average rise in CPI-U was low for many years, ending in the early or mid 1960s. Drastically higher followed for many years, and some think this change was intended by the powers that were. (Backstabbing is a tool in the toolkit.)
Mark, if I had CDs maturing right now, I’d probably go the 1-year route and take the 1%. I Bonds, of course, can also be sold after a year, with a three-month interest penalty. A 5-year TIPS would be attractive if I needed to fill a spot in my ladder, I’d definitely be OK with that investment.
The negative real returns looks awful over five years, Dave, but so does .21%. I think you can make the case that the best option on this list is 1% on a 1-yr CD from Ally… at least until we see what Treasury offers on May 1.