CD Maturing? Time to Re-Evaluate Your “Sleep Quotient”

I usually listen to the weekend radio "money talk" shows when I’m running errands on a Saturday. Today was no exception, and I couldn’t help but notice that all the callers today had variations of the same question… What can I do about my CD/Bond that just came/is about to come due?

Some, but not all, were retirees who were looking at 40-50% drops in the rates they have become accustomed to earning, but everybody was feeling the pain. Welcome to the downside of economic stimulus, specifically the fine tuning of the economy by Federal Reserve manipulation of short term interest rates.

The financial press has made much of the stimulative effect of the recent Federal Reserve rate cuts, and Wall Street certainly encourages and embraces them. And it’s great that businesses can borrow money cheaper. Right now, it’s probably necessary, too. But there is a down side to this, just as there are two sides to every transaction. In this case, the two sides are the borrowers and the lender/investors. And the unhappy group right now is that second group, represented today by those poor, befuddled callers.

I have heard a bit of this myself from my clients, mostly boomer age, especially in light of the fact that many of our higher rated bonds and CDs are currently being “called” early by the issuers (This happens any time interest rates are low, so the issuers can re-borrow at the lower rates). Just as with today's callers, my clients are also concerned about the greatly reduced returns on the conservative portion of their money. So what’s an investor to do? Now I can’t give specific advice here, but here is one thing I believe everyone should do any time a CD or bond matures or is called early. Consider this as an opportunity to reevaluate your posture relative to risk. By definition, it is a time when you have cash, so it’s the easiest time to tweak your investment allocations.

With the current low returns on conservative investments, and with many stocks available at 20% or more off of last year’s high prices, can your risk tolerance handle some additional stock in your portfolio? Keep in mind, there is no conservative bond or CD strategy that can match the 10% or so average return earned by stocks in the past century or so.

When I first meet with a new client, I always draw them a chart of a nice smooth modestly uptrending line that grows slowly at first, then a little more rapidly towards the end. Then, I’ll draw two or three more lines, each progressively less smooth (more volatile), rising both above and below our smooth trend line, but generally following a somewhat higher trajectory. The more volatile the path, the higher the trendline it follows. This is my attempt to graphically portray the risk reward tradeoff we all face. Then I ask some questions, all geared towards determining their risk tolerance, or as I sometimes call it, their “sleep quotient.”

One of the questions I always ask is, “How would you feel as we pass through this point?” And I will point to one of the times when the volatile lines sit below the nice safe smooth one. This is a key question, and the answers are always revealing. Some are totally averse to risk, as was the lady caller today who didn’t even want to consider buying a CD at an out of town bank that was offering higher interest.

Often, what a client perceives as conservatism is just ignorance about the alternatives. If that lady understood FDIC insurance, would that out of town bank scare her? What about a Treasury or Federal Agency bond? An investment grade corporate bond? A “blue chip,” high dividend paying stock?

Now each item on that list has successively more “risk,” but is still considered conservative. And the more you learn about investments, the better equipped you are to find just the right spot on the risk/reward spectrum for your own sleep quotient. And generally, the more you know, the better able you are able to handle reasonable risks.

But I am “preaching to the choir” here. The very fact that you are a reader of personal finance articles means that you are open to learn. And that, in itself, puts you way ahead of the vast majority of the population. And “you will be well rewarded in the long run, Grasshopper*.” :-) Bob

P.S. For you boomers, you may want to refer back to my previous article, "Are There Risks of Being Too Conservative?, which elaborates on these point with some boomer age specific addons.

* Shameless David Carradine Kung Fu reference

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