Which to choose?
It is an open question whether to choose bonds at all. With interest rate higher lately, the interest on bonds has become attractive.
There are several factors to consider. While I usually focus on stock dividends, because of recent increase in interest rates, CDs and bonds have become appealing..
Interest rates are up. One can now easily find CDs and other accounts with interest rates above 5%. This is higher than the average dividend yield I have of slightly over 3%. Of course some dividend yields are higher and some lower, but my recent average is about 3%.
While the yield on bond funds can rival CDs as well, there is also the matter of principal. When rates increase, the price of a bond decreases. Similarly, when rates decline, bond prices increase. As a result, buying a bond fund in a rising interest rate environment means decreased prices for the underlying bonds. So while one can collect higher interest, it is possible to lose money on one’s principal if one sells before maturity. Because bond funds usually have mixed maturity dates, the opportunity to lose principal is real.
As a result, when interest rates rival dividend yields, I tend to stick to CDs. As previously mentioned, brokered CDs are often available from a broker. These are bank CDs, backed by the FDIC, often with higher rates than one can get directly from the bank involved. I look to only short-term CDs, like six months. When the CD matures, I receive the interest, plus the original principal. At that time, I have a choice whether to buy another CD or simply add the returned principal to my “investable” funds.
There is no possibility of losing money when investing in FDIC-backed CDs.
Do you use brokered CDs? Let me know you experience here.
The Extinguisher is from the 1856 book “Shadows” by Charles H. Bennett. Courtesy Harvard University Library.
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