Yes, Kitty. It is a valid comparison. Because you can invest in a bond fund or you can invest in a CD. Since investing in a CD beats a bond fund 90% of the time, it is best to stay away from bond funds and just go with the CD.

I’m not suggesting anyone lock in a 5-year CD at this point. But if I was going to invest in a bond fund or a CD, I’d go with the CD. At this point, I wouldn’t do either.

@Stacey: “But I’m a firm believer that all these bailouts/handouts/Tarp crap is going to come home to roost. And when that happens, inflation will increase, thus our investment in the I-series.”
This seems to be almost obvious – that the increase in money supply that we have will cause inflation. But is it so obvious? From what I read there are two things which control inflation: money supply and velocity of money. We have ample money supply but velocity is almost non-existent. Banks aren’t lending, people aren’t buying, unemployment is increasing. A lot of money disappeared into a black whole and newly printed/borrowed money may well disappear in potential losses in commercial real estate and credit card defaults. Sure, we may get stagflation as in the 80s, but back then it was driven by rising oil prices – if I am not mistaken. Not clear if this is what will see.

I wish I could be sure that we’d have inflation, then I’d know how to invest my money. I’d be happily convinced of this since I really don’t know the best way to allocate my money nowadays.

@RA: “One of the most valuable things I learned from Scott Burns over the years is that a 5-yr CD will outperform 90% of all bond funds over a 5 year period.”
I don’t know if it makes sense to lock today’s rate for 5 years. There is not much room for the rates to decrease. Now when the rates do increase, the money in bond funds would lose value, so a 5 year CD can still outperform.

But is it a valid comparison? A CD is a fixed income investment. A bond fund is not – its value fluctuates with value of bonds on secondary market. So wouldn’t a comparison with individual bonds be better? Not only government, but also municipal and corporate. Yes there is risk with investing in municipal bonds and corporate bonds, but it is a smaller risk than with stocks.

One of the most valuable things I learned from Scott Burns over the years is that a 5-yr CD will outperform 90% of all bond funds over a 5 year period. The only fund which can consistently beat CDs is Vanguard GNMA. But then you have to make a bet on interest rates because of the fluctuating NAV which will ruin a good yield.

TIPs and I bonds were great when they paid 3% above inflation. But at 2%, they are marginable.

Many investors have extremely short performance time frames so they chase one asset class to the next.

That’s why diversification is important and having a plan is even more important.

Bozo

Great article and you have some sharp readers of your blog. They are a head and shoulders above most PF blog commenters.. Well done everybody!

Bozo, for our situation I prefer I-series over CD’s for 2 reasons: no state income tax on earnings (3% and undoubtedly heading north here in IL!) and down the road I could even get out of paying federal tax if: 1) we use them for the boys’ college and 2) our income is low enough to avoid the tax (yes, there is a limit and it gets phased out. Right now we’d be out of luck, but in 13 years, that could change.) Even if we don’t use them for college I could hold them until we’re ripe ol’ seniors and our income would certainly be lower by then and presumably taxed at the lowest/lower rates. Or we’ll just be dead and the kids can inherit them I’m all about depriving the government of taxes on my hard-earned savings!!

Lucky for you, Bozo, that you can save in a tax-deferred acct. Our income, coupled w/my husband’s 401k participation, prevent that unless I did nondeductible IRA contributions (which are then a nuisance to track, but doable.)

Admittedly, I do a lot of rate-chasing. However, in a tax-deferred account, I’ve found over the past 2 1/2 years that my real return has exceeded that of I Bonds handily. TIPS as well, except for the time when the real return nudged into 3% territory. I’m not a big fan of TIPS funds (too volatile for retirement planning, in my view). Individual TIPS bonds, well, there’s the liquidity issue unless you have the patience to build a ladder of 5 year TIPS. And then I’m talking tax-deferred, anyway.

Anyway, I suspect the dearth of analysis regarding CDs is due mostly to the ephemeral nature of the data. There really is no accurate historical data base of the “best” CD rates at any given point in time, and rates vary widely with exogenous factors (teaser rates, “local specials”, you name it).

All I can say to fans of fixed income (and I am one) is: don’t dismiss CDs. They may not be sexy, but they can anchor the bond part of your AA.

Bozo