It’s been slim pickings on CD rates lately. But the dry spell may be over thanks to a 7-year Security Service Federal Credit Union CD, paying 3.50 percent APY. Though I’d love to take credit for finding it, the credit goes to a client who brought it to my attention. Aside from the high rate, it offers a reasonable early withdrawal penalty that provides protection against a potential bond bubble. Here’s more about the CD, and why I opened one up late last week.
Security Service Rates
This CD rate for the 7-year CD can vary by zip code, but generally ranges from 3.35 percent APY for a $500 deposit to 3.50 percent for $100,000 or more. By comparison, a 7-year Treasury Bond was yielding only 2.28 percent, while my favorite core bond fund, the Vanguard Total Bond Fund (BND), was only yielding 2.68 percent.
Of course, I was suspicious at first that it was another bait and switch tactic such as the American First Assurance CD advertisements I’ve seen to sell annuities. This one, however, checked out. Security Service is a six billion dollar credit union based in San Antonio, Texas.Bankrate.com gives them a three star (performing) Safe and Sound rating. More importantly, it’s insured by the NCUA, an agency of the US Government, for $250,000 per depositor. There are ways of getting millions of dollars in insurance by titling the accounts to maximize insurance as NCUA and FDIC rules are virtually identical.
Just as important as the rate, this CD has a reasonable early withdrawal penalty of one year’s interest, though it can be even lower if the CD is less than a year old. This is a particularly important feature if certain economists, like Wells Fargo’s John Silvia, are right and we get into a rising rate environment.
Though I don’t know with certainty that rising rates are coming, it could have a devastating effect on bonds. The potential bubble might cause intermediate term bonds like the Vanguard Total Bond Fund, or the 7-year Treasury, to fall by about five percent for each one percent increase in rates. For example, a rapid three percent increase could cause these bonds to lose 15 percent of their value.
With this 7-year CD, however, I would just pay the 3.50% early withdrawal penalty and invest it in a CD paying that three percent greater rate. If this happened, I’d avoid the 15 percent loss and earn the penalty back via that higher rate in a bit more than a year. And if rates stay low, I would still earn far more than the two bond alternatives.
So what I have bought is a US Government bond yielding 3.50 percent, with a “put” giving me the right to sell it back to them for 96.5 percent of par, plus I get to keep the accrued interest.
A few caveats
Unlike Pentagon Federal Credit Union, which has open membership via an organization anyone can join, Security Service is not technically open membership. The Credit Union’s Senior Vice President, John Worthington, told me they view themselves as easy to join, noting their web site states there are more than 2,100 ways to join. I happened to have met two different criteria to join. It’s easier to qualify living in Texas, Colorado, and Utah, where they have branches, but one can qualify living anywhere.
Another caveat is that Security Service does not allow partial withdrawals. They have a neat feature where they allow withdrawals of accrued interest left to compound without penalty, but the full penalty applies if one dollar of principal is withdrawn. Like the Ally Bank CD, one can carve funds into smaller CDs to mitigate the risk, though lower CD amounts pay lower rates.
Rarely in the investing world do we find real products that pay more and have less risk. This anomaly occurs for three reasons:
- The government creates a market inefficiency with FDIC and NCUA insurance, eliminating default risk for levels that can benefit small investors, but not the likes of Goldman Sachs with billions of dollars to invest.
- No one in my financial services industry benefits from telling you about this CD. If they did, billions of dollars a day would be flowing in and the credit union would cut it off in minutes.
- Credit Unions are not-for-profits and view their higher rates as giving dividends back to shareholders.
The potential of a bond bubble is real. This CD and Ally Bank’s five year CD give us higher rates with less risk. It’s a little more work but I highly recommend it. If there is no branch where you live, give them a ring to see if you qualify to join. But be sure to read the disclosure statement as it may have changed since I opened mine last week.
Allan S. Roth is the founder of Wealth Logic, an hourly based financial planning and investment advisory firm that advises clients with portfolios ranging from $10,000 to $50 million. He is mocked on a semi-regular basis by some financial professionals for his hourly fee model and its obvious inability to make him rich. Roth is also the author of How A Second Grader Beats Wall Street. He teaches behavioral finance at the University of Denver and is an adjunct faculty member at Colorado College.