Q Dear Rick:
My wife and I can’t agree on what to do with a maturing CD that we hope you can help us with. We are in our early 50s and are very conservative investors. Our only investments are a variety of CDs. In the past we have invested in the market with some success; however, we just don’t feel comfortable investing in it anymore. We have decided just to stay in CDs. My wife and I both have pensions that will more than cover our retirement needs. We just had a $100,000 CD mature and the issue is whether we buy another five-year CD or use the money to pay off our home. Currently, we owe about $75,000 on our home and our interest rate is six percent. We have looked into refinancing but it didn’t seem to make sense for us. My wife and I both work and are in a 28 percent tax bracket. What would you do? Would you pay off the mortgage or would you go into another five-year CD? The rate we were quoted on a five-year CD is about 2¼ percent.
A Dear Dan:
First, I have no problem with you investing in CDs. Although, that may not be the portfolio I would recommend, I believe one of the most important things is that investors are comfortable with their investments. Since you and your wife are only comfortable with CDs, as far as I’m concerned that is the investment you should stay in. I believe one of the problems investors run into is when they invest in something outside their comfort zone and then panic at the first sign of a downturn. Therefore, CDs are an appropriate investment for you.
In deciding what to do with your maturing CD, the first thing I would look at is the after-tax cost of your mortgage versus your after tax return in a CD. If I assume that you are itemizing your deductions, which it appears you are, your six percent mortgage is costing you approximately four percent. On the other hand, the return on your CD after taxes is approximately 1½ percent. After all, not only do you have to pay federal taxes on the interest you earn, but in addition you have to pay state taxes. Therefore, it seems like a slam dunk to me that you should use the proceeds from the CD to pay off your mortgage. After all, by paying off the mortgage, you’re getting a four percent after tax return on your money which is more than double the after-tax return on your CD.
Do I recommend that everyone use their investment dollars to pay off their mortgage? My answer is no. For those investing in the market, my belief is that over the long run they will receive a much better rate of return than the after tax cost of the mortgage. However, for conservative investors who are investing in CDs and U.S. treasuries, paying off a mortgage is generally a positive fiscal move. Particularly, in this environment of low interest rates, very conservative investors ought to give consideration to paying off their mortgages. I think you would find that for the conservative investor, paying down the mortgage will give you a substantially better return of your money than investing in a CD.
One further note regarding CDs, you should always shop CDs around. Don’t assume that all rates are the same because they are not. You may find that by shopping your CD around you can potentially increase your return by 10 or 20 percent. In that regard, when you shop CDs around, only use CDs that are federally insured. A good website that you can use to shop federally insured CDs is www.bankrate.com.