A Word to the Wise on Bank CDs
Q: I am trying to determine if now is the right time to purchase a certificate of deposit at my bank. Rates are higher than they have been in years, and I am tempted. If I do succumb, how long a CD term should I go for? I keep thinking I should remain fairly liquid in this environment.-- H.L.B .
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A: Clearly, interest rates offered investors by savings institutions these days are the most attractive they have been in several years. Just since the beginning of the year, according to one study, the average annual yield offered on a six-month certificate of deposit has risen to 3.93% from 2.79%. On a one-year certificate, the average percentage yield has jumped to 4.74% from 3.07%.
That said, the issue of whether you should bite now remains. The Federal Reserve Board’s decision last week to again raise the interest rate banks charge one another for overnight loans--the sixth increase this year--is sure to lead to yet higher rates for consumers, both as borrowers and savers. Still, are those rates going to be the ones at which you want to lock up your money? And if so, for how long?
The answers depend in large part on the composition of your portfolio. Clearly, certificates of deposit should not be your only investment. Of course, the funds are covered by federal deposit insurance and are as safe as any investment can be, but their returns lag those paid by other investments, so you are paying for the security. If CDs are all you hold and you want to purchase more of them now, you should stick to short-term notes, such as three- or six-month certificates.
An investor with a broad portfolio and sufficient funds might consider “laddering” purchases by buying CDs of various maturities, from three months to five years. But to give yourself the maximum flexibility in what is still a volatile market, many experts say, the emphasis should be on the short-term CDs.
Whether the rates currently offered by banks--albeit the most attractive yields in a year--are as high as they’re going to go will depend on how successful the Federal Reserve Board thinks its anti-inflation policy is over the next several months. If inflation isn’t whipped with this rate increase, there are likely to be further increases--which will give savers opportunities to bring home higher yields and more chances to agonize over the timing of their CD purchases. If the Fed’s effort is successful, the current CD rates are likely to remain in effect for a considerable time.
Our experts urge you follow your instincts. If you are tempted by CD rates, stick to those with shorter-term maturities. If you find that rates are peaking, you can move to lock up your money at that point. Timing market peaks and valleys is difficult for both professional and individual investors alike. But you can be wise about your strategy, and it is apparent that you are already on the right track.
T-Bills and CDs: Tax Rules Are Different
Q: Please help me compare the yields offered on 26-week U.S. Treasury bills and six-month certificates of deposit. Is the annual percentage yield offered on a CD comparable to the interest rate paid on a Treasury bill? And if they are both, say, 5%, is one better than the other?-- O.E.L .
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A: From a strictly mathematical perspective, the annual percentage yield on a six-month CD is comparable to the interest rate paid on a 26-week Treasury bill. If the rates are identical, then the yields are mathematically the same.
The Treasury bill is the better investment, however. Why? Two reasons. The simplest one is that interest paid on Treasury securities is not subject to state taxes. In California, that means investors, depending on their tax bracket, automatically keep from 1% to 11% more of the interest they earn on government securities than on bank notes.
The other reason is that Treasury bills (not Treasury notes of a duration greater than one year) are sold at discount and redeemed for full face value at maturity. This means that a six-month $1,000 note paying 5% is purchased for just $975. Investors tie up less of their money and retain the opportunity to invest it elsewhere, perhaps at better rates.
Sorting Out Personal Funds in a Divorce
Q: I understand that gifts and inheritances are considered separate property in a community property state such as California. But what about compensatory and punitive damages received subsequent to the settlement of a personal injury lawsuit? And what about the equity in a home whose down payment came from a gift to just one of the spouses? --H.J.F .
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A: Generally speaking, lawsuit settlements are considered community property unless the injury was caused by one of the spouses. In that case, the settlement is the property of the injured spouse. If the couple is divorced after the settlement, the funds are assigned to the injured spouse. The only exception to this is when the funds have become so commingled that they cannot be sorted out and assigned. Money from a settlement is considered the separate property of the spouse receiving it if the cause of action arose after separation or divorce.
Gifts used to make a down payment on a house are far trickier. Much depends on how the spouses took possession of the house and whether community property funds are used to pay the mortgage. If the home was purchased as community property and joint funds are used to pay the mortgage, the gift could be deemed to be inseparable.
Even if the home is not held as community property and was purchased pursuant to an agreement delineating the source of the funds, the source of the mortgage payments could cloud any claim to the down payment funds. To help you sort all this out, you may well need to consult an attorney or another trusted professional adviser.
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Carla Lazzareschi cannot answer mail individually but will respond in this column to financial questions of general interest. Please do not telephone. Write to Money Talk, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA, 90053.
