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Author: imdajunkman Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 35345  
Subject: Re: CD or treasury bill ? Date: 6/20/2006 5:31 PM
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Loki writes: ”The issue in choosing between "fixed-income" choices of the same risk level that fit liquidity needs is simply yield. In high state and local tax situations, obviously Treasuries and TIPS (and sometimes other government issues) get a comparative boost in yield compared to CDs or Money Markets (except "Federal" Money Markets) or Corporates, etc. But a boost of 25 or even 50 basis points doesn't make up for a 100 basis point difference in interest payments."

Loki,

That argument is so simple-minded and so reductionist that you ought to be ashamed of yourself. You know better than that. Yield is simply one the multitude of factors that savers have to make decisions about when choosing between FI instruments that are equivalent in credit quality and maturity. Also, your attempt to knock the yields currently to be obtained from Treasuries by pointing to a 6.5% CD that you can access is to overlook the larger issue that no savings vehicle, on average and over the long haul, will ever yield a real rate of return once taxes and inflation are considered. Yes, such CD's ought to be grabbed when they are available. No one would attempt to argue they shouldn't be. But when the yield advantage of CD's is small, other factors might well argue their avoidance.

To repeat, going for the few basis points that CD might provide is the better choice within the narrow confirms of the savings game. But it's a losing move within the larger picture. The current yield from that CD yield doesn't offer a real rate of return, and when the principal is returned, it, too, will have suffered the effects of inflation. All choosing such a vehicle has done is slow down the erosive effects of inflation and mitigate a bit the effect of taxes. But real gains have not been achieved.

Yes, it's possible to construct portfolios that aren't required to achieve real rates of return –-which you are apparently doing by saving massively. But that's not a strategy that interests me, nor is it one that is available to most people for their not having constructed their lives to have such an abundance of discretional income, which they then squirrel away for retirement, hoping that inflation will remain benign until their death.

Take a look at the following list of numbers, which roughly reflects how the investment portion of my portfolio is constructed. (The savings portion, mainly Treasury ladders, is managed separately. There, the goal is merely to conserve purchasing power. When I'm investing, I want a real rate of return.) You, OTOH, choose to call what you are doing “investing”. But it isn't investing. It is saving. Yes, it's a viable strategy, but it is a costly one, too, in terms of the long-term risks you are accepting and the opportunities you are avoiding.

CPN CY YTM
8.00 23.7% 23.8%
7.50 18.3% 24.9%
11.50 16.8% 21.8%
9.25 15.8% 16.3%
12.25 15.6% 21.8%
11.00 13.4% 15.4%
10.50 13.4% 19.8%
11.00 11.0% 11.0%
10.50 10.9% 11.6%
10.00 10.8% 13.4%
10.38 10.8% 11.4%
7.75 10.4% 11.7%
7.50 9.5% 11.7%
7.88 9.3% 9.8%
8.63 9.2% 10.9%
9.88 9.2% 7.0%
9.90 9.1% 8.1%
7.50 9.0% 23.2%
8.90 8.4% 8.9%
6.63 8.2% 12.9%
8.50 8.0% 4.4%
6.63 7.9% 8.1%
7.20 7.8% 9.7%
8.17 7.4% 8.2%
4.75 7.4% 19.2%
7.41 7.4% 7.4%
7.63 7.3% 4.8%
7.35 7.1% 7.0%
7.25 7.1% 7.1%
7.00 7.0% 7.0%
7.95 6.8% 6.5%
6.60 6.6% 8.0%
6.63 6.5% 6.4%
5.60 6.4% 6.5%
5.60 6.3% 6.8%
6.00 6.2% 9.7%
6.00 6.0% 6.0%
5.00 4.8% 4.6%
4.50 4.7% 5.0%
3.65 3.8% 5.3%
3.00 3.3% 4.0%
3.20 3.3% 4.2%
0.00 0.0% 8.7%
0.00 0.0% 8.0%
0.00 0.0% 7.5%
0.00 0.0% 7.0%
0.00 0.0% 6.6%
0.00 0.0% 6.4%

Yes, my returns are all over the map. Some of that stuff clearly doesn't offer a real rate of return, and as the bonds mature, I'll try to improve my returns. (Also, some of those YTM are state munis, meaning their effective yield is much higher, and some of the zeros are tax-advantaged agencies, which again boosts effective yield.) With other issues, I'm clearly winning the fixed-income game. Some of my current yields are nearly 4 times that of your 6.5% CD. Plus when my prinicipal is returned, I'll capture 200% worth of cap gains. (E.g., Xerox's 8's of '27 bought at 33.) By for much will the purchasing power of that CD been degraded, over its holding period, by the effects of inflation?

Immediately, you'll argue that our risks aren't similar, that a CD is guaranteed and Xerox is junk-rated. Do you seriously think Xerox will blow up before those bonds mature? The market is pricing them as if they are risky, which they are, but on a risk-adjust basis, which is the only basis that matters when comparing investments, which vehicle has the better alpha? a CD whose yield offers a less than bond point over Treasuries, or a bond with an 8% coupon, bought at a 67% discount, that has traded for five years now at par or better and from which I could exit on the instant with a huge profit even if adverse news were announced?

Safety of nominal principal costs money, and the costs are typically bigger than I'm willing to pay for all but a portion of my portfolio. What CD's can't protect against is inflation. So, although they are “safe” in the short run, they are hugely risky in the long run. Years and years ago I heard the founder of Benham's (which later was absorbed into American Century) make that point in a talk held for shareholders, and the point struck home. By being short-term safe, I was being long-term risky. That's not a good trade. That's not a trade I think is prudent. That's not a trade I will accept.

I love the Treasury Department and the moves they've made to give the small investor access to debt instruments formerly beyond the reach of the small investor. I remember the days of carrying bags full of money --$10,000, in fact— into town so I could buy a single T-Bill. So I'm one of their good customers. But I also realizes the costs I'm paying for dealing with them instead of getting off my butt and getting out into the investing world and looking for serious money. The opportunities are there even though, right now, the market is “tight”. But right now and being lazy and I'm parking money as a saver, while I tread water as an investor, and right now, the 6-months T-Bill is a compfortable place to be.

Charlie
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