Back in October 2015, I bought into a CD special from Northwest Federal Credit Union. It was a 3-year CD at 3%, which was a very good rate at that time. That CD is maturing next month. Another reader also bought into this CD at the same time. She asked me what I would do with the money after the CD matures.
It’s simpler for me personally because after I left my full-time job I no longer have paychecks. I will need money for my expenses next year. So I will just divide up the money and buy some 3-month and 6-month Treasury bills, timed to when I will need the money for spending.
What if you don’t need the money for spending? I see several good options.
Pay Down the Mortgage
A small part of the money from my maturing CD will also go toward paying off my mortgage. Under the new tax law many people will just take the standard deduction. Mortgage interest will no longer give them an extra tax deduction. In that case if your mortgage is in the 4% range, paying down the mortgage gives you a 4% after-tax return.
However, paying down the mortgage is more like a one-way street. It may not be a good option if you need the money for something else in the future.
Interest rates on CDs came up this year. 3% was a great deal 3 years ago. Nowadays it’s very easy to find another CD above 3%, although it’s still rare to see something offering 4%, let alone 4% after tax. In essence 4% has become the new 3%. The best rate I see on DepositAccounts.com is about 3.3%.
Buying a Treasury note is another option. The best CDs from credit unions used to offer a much better rate over Treasuries. When I bought the 3% CD 3 years ago, the yield on a 3-year Treasury note was only 0.9%. Now the gap between the best CDs and comparable Treasury notes is much smaller. When you take into consideration that Treasuries are free from state income tax, the difference shrinks further.
U.S. Treasury sells 2-year, 3-year, 5-year and 7-year Treasury notes every month (see calendar of announcement dates). See Daily Treasury Yield Curve Rates for where the yields are for different maturities. You can buy them directly in your Vanguard, Fidelity, or Schwab brokerage account. The process is similar to how to buy Treasury bills. You see the note offered in late morning/early afternoon on the announcement date. You place your order and you just wait.
If hunting for another CD or buying a Treasury note is too much hassle, putting the money in a bond fund would be the simplest. Yes there will be price fluctuations, but over time it evens out with reinvested interest.
Don’t fall for the “interest rates will go up” talk. Interest rates have gone up. Whether they will go up further, and if so by how much, aren’t very clear. Bond prices at set by the market with their expectations of future directions. If everyone knows interest rates will go up a lot, nobody will buy the bonds at prices we see today. They will just wait to buy them at lower prices later. Enough people waiting causes the prices to arrive at where they are today.
There are bond funds of different types and terms. I would treat all prices as fair. You pick by the level of risk you’d like to take. Short-term bond funds have lower risk and lower expected returns than intermediate-term and long-term bond funds. Treasury bond funds have lower risk and lower expected returns than corporate bond funds. Bond index funds that include both Treasury and corporate bonds are somewhere in between. Muni bond funds are federal income tax free, good for taxable accounts in higher tax brackets.
Forget about picking a “sweet spot.” There are no sweet spots in bonds. If we can figure out where the sweet spots are with some rudimentary analysis, institutions with powerful computers and sophisticated tools would’ve been there ten steps ahead already. They don’t leave sweet spots for us to discover.
I have more CDs maturing in December. I’m planning to put that money in Vanguard Short-Term Inflation-Protected Securities Index Fund (VTAPX). This fund invests in short-term TIPS — inflation indexed Treasuries with maturities of up to 5 years. The expense ratio is very low at 0.06%. Holding TIPS in a fund makes tax reporting much easier than holding individual TIPS in a taxable account. I’m picking this fund because I’d like to have inflation protection and low level of risk when that money will fund my spending in the next several years.