The best short-term non-junk bond investments are… (Drum roll, please.) …CDs. Numbers don't lie. Well, as we all know, sometimes they do lie; but they are not lying in this case.
Yes, I know, CDs are not a sexy investment. In fact, investing in CDs is disappointing for many more sophisticated investors. You spend the time to become expert in various bond investments; and, then, the stinking CDs―an investment less knowledgeable investors understand―are more attractive.
Do not let whether an investment is sexy or sophisticated influence your investment decisions. Whatever the numbers favor is what you should purchase and hold.
The following investments are covered in the spreadsheet below:
- Mountain America Credit Union (MACU) 5-Year CD: Anyone in the U.S. can buy this CD. There is a $500 minimum investment. You need to join MACU to be eligible for the CD. To join MACU, you will probably need to join the American Consumer Council; and you will need to put $25 into a savings account. Membership in the American Consumer Council is free for those joining an associated credit union.
- Salem Five Bank (SFB) 3-Year CD: Anyone in the U.S. can buy this CD. There is a $10,000 minimum investment. This CD is available online only.
- Salem Five Bank (SFB) 1.5-Year CD: Anyone in the U.S. can buy this CD. There is a $10,000 minimum investment. This CD is available online only.
- SPDR Nuveen Barclays Capital Short-Term Municipal Bond ETF (SHM)
- Vanguard Short-Term Corporate Bond ETF (VCSH)
- SHM Data Altered So the Bonds in the Fund Are Represented, Versus the Fund Itself: This equates to a large basket of individual municipal bonds with, on average, 3.21 years to maturity.
- VCSH Data Altered So the Bonds in the Fund Are Represented, Versus the Fund Itself: This equates to a large basket of individual corporate bonds with, on average, 3 years to maturity.
This spreadsheet assumes a $100,000 investment, 25% federal income tax rate, 15% federal capital gains tax rate, and no applicable state or local taxes. Please see my earlier articles entitled "Determining the Best Bond Funds: True Future Total Return", "The True Yield of Your Bond Investments", and "Ignore Total Return in Evaluating Bond Funds" for the methodology behind the spreadsheet.
|Credit Union, Bank, Fund, Etc.||Yield Type (YTM, YTW, or OAY)||Yield||Shares||Price||Amount||Personal Expenses||Personal Expenses %||Holding Period (Years)||Annualized Personal Expenses %||Fund Expense Ratio||Annual Default Losses||Last Distribution||Distributions Per Year||Interest Rate||Interest Tax Rate||Annual Interest Tax Loss||Current Price vs. Par Value Differences Gain or Loss||Non-Yield Capital Gain or Loss||Annualized Non-Yield Capital Gain or Loss||Annualized Non-Yield Capital Gain or Loss %||Capital Gain or Loss Tax Rate||Annual Capital Gain or Loss Tax Effect||Annual Adjusted True Yield||As of Date|
(1) The "IB" in "SHM IB" and "VCSH IB" is an abbreviation for individual bonds.
(2) The Yields for SHM ETF, VCSH ETF, SHM IB, and VCSH IB were adjusted slightly to estimate the Yields as of market close on 10/17/12.
(3) The Yields for SHM IB and VCSH IB were adjusted slightly to eliminate the effect of SHM being slightly leveraged and VCSH having a slight cash position.
(4) For SHM IB and VCSH IB, under Personal Expenses, I assumed 10 different $10,000 bonds purchased at a transaction cost of $6.95 each, with a loss of 71 basis points (i.e., 0.71% or $710 in total) due to (half of the) bid/ask spreads.
(5) I used average time-to-maturity as the Holding Period for SHM ETF, VCSH ETF, SHM IB, and VCSH IB.
(6) Annual Default Losses: Do not depend on the figures I placed in this column to be correct. These are guesstimate figures I developed months ago. Actual default losses may be more or less. In fact, they may be much higher than I indicated here. Also, in a given year, default losses can be much greater or less than they were in preceding years. It is true, though, that, historically, default losses on municipal bonds have been very small.
Credit Union, Bank, Fund, or Individual Bonds Basket
Holding Period (Years)
Adjusted True Yields
U.S. Federal Income Tax Bracket
MACU 5-Year CD
SFB 3-Year CD
SFB 1.5-Year CD
SHM Muni Bond ETF
VCSH Corp Bond ETF
SHM Basket of Individual Muni Bonds
VCSH Basket of Individual Corp Bonds
In every tax bracket, the CDs are the best investment. In fact, the corporate bond ETF, municipal bond ETF, basket of corporate bonds, and basket of municipal bonds never come close to being better than the CDs. The municipal bond ETF and basket of municipal bonds fared worse than the corporate bond ETF and basket of corporate bonds. The individual bond baskets fared worse than the ETFs due to the high trading costs associated with making small (i.e., $10,000) bond purchases and the short holding periods. Even if the trading costs were zero, the individual bond baskets would not be better than the CDs.
I did not evaluate Treasury notes, including ETFs such as iShares Barclays 1-3 Year Treasury Bond (SHY), iShares Barclays Short Treasury Bond (SHV), and iShares Barclays 3-7 Year Treasury Bond (IEI). There was no need. As of 10/17/12, the 3-year Treasury note interest rate was 0.41%. Currently, all Treasuries, whether short-term or not, are very poor investments. I also did not evaluate iShares S&P Short-Term National AMT-Free Municipal Bond (SUB). I did not need to evaluate this additional municipal bond ETF, as its performance would have been about the same as SHM's. I also did not evaluate iShares Barclays 1-3 Year Credit Bond (CSJ), iShares Barclays Intermediate Credit Bond (CIU), SPDR Barclays Capital Short-Term Corporate Bond (SCPB), SPDR Barclays Capital Intermediate-Term Corporate Bond (ITR), Guggenheim BulletShares 2013 Corporate Bond (BSCD), Guggenheim BulletShares 2014 Corporate Bond (BSCE), Guggenheim BulletShares 2015 Corporate Bond (BSCG), and Guggenheim BulletShares 2016 Corporate Bond (BSCH). I took a look at some of the associated data, and these additional corporate bond ETFs would have performed similarly to VCSH. CDs are a better investment.
CDs have an additional advantage over funds like SHY, SHV, IEI, SHM, SUB, VCSH, CSJ, CIU, SCPB, and ITR. In holding the CDs to maturity, you can avoid the risk of interest rates rising and a loss in principal. CDs have an additional advantage over BSCD, BSCE, BSCG, and BSCH in that these ETFs are converting to holding shorter-term, lower-interest instruments and cash in, what appears to be, their final year of existence.
CDs consistently measured as the best investment despite the fact I only used CDs available to everyone in the U.S. in the evaluation. If I used CDs for which some, but not other, people qualify, the results would have been even more in favor of CDs. For instance, for $5 you can join the Connexus (charitable and educational) Association. Then, you can join the Connexus Credit Union. The Connexus Credit Union appears to have a 3-year CD with a 1.75% interest rate. You need to establish a checking account and, each month, have at least one direct deposit and ten other transactions of a certain ilk (e.g., debit card transactions) to qualify for the 1.75% rate.
On 10/17/12, the most outstanding CD interest rates I saw online for Texas were:
(I have not investigated these CD offers.)
- 3.03% for a 3-year CD, any amount, County & Municipal Employees Credit Union, available to some people in Hidalgo County.
- 2.27% for a 1-year CD, 2.01% for a 6-month CD, $1,000 minimum, RICH-SEAPAK Federal Credit Union, available to employees of Rich's Consumer Brands Division.
I do not know what great interest rates are available to certain people in the other 49 states. Three cheers for the stinking CDs. Short-term fixed-income investing would be far worse without them.