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Sunday, April 26, 2009

Reminder: Get Out Of Demand Notes

Update: I have attracted some hostile comments. To clarify my position:

No one who has a low tolerance for risk should be in GMAC Demand Notes. If you are using them for long term savings, get out. If you understand that you are chasing returns, and that this is similar to "junk bonds", and you have a diversified portfolio, have at it.

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A friend of mine has some of his money in GMAC Demand Notes. I recently reminded him that this is crazy--they are basically unsecured loans to GMAC.

That's why they pay 4%, compared with FDIC insured rates of 2.25% at GMAC Bank.

With GM looking at a possible bankrupcy, and GMAC shaky due to mortgage exposure, no one should be in GMAC Demand Notes. The 1.75% extra yield is not worth the risk. If you have money that you don't mind investing in "junk" debt, buy a diversified junk bond fund or ETF,which gives you some protection against a single company default.

The same goes for Ford's Interest Advantage.

9 comments:

XT_Guy said...

I see why you are in engineering and not Financial. GMAC was given Bank status by the Fed Reserve back in January. While Demand Notes are not FDIC insured,GMAC is no more likely to fail than any other Bank that accepted TARP bail out funds.

The Auto Prophet said...

@XT_Guy: Demand notes are not FDIC insured, as you say. GMAC is not out of the woods, they have a lot of mortgage exposure. Will the government prop them up? Probably. But there is a good reason they demand notes are paying such high interest: they are basically junk bonds.

People with money to risk should be buying diversified funds to mitigate possible defaults.

People without money to risk should be buying insured (FDIC or government) instruments.

Anonymous said...

Imagine that, an engineer pontificating, how novel.
Stick to engineering and leave business to the businessmen. Demand Notes are paying higher interest because they are unsecured, NOT because of the company’s credit rating. Demand Notes have ALWAYS paid above market rates (even when they had good credit ratings) in order to attract investors. Your poor/alarmist financial advice does more harm than good. How much of the FDIC's current obligation can it fulfill? "Insured by the FDIC" helps the ignorant sleep better at night but does absolutely nothing for your portfolio, including limiting exposure to risk. GMAC Demand Notes are a valuable tool in a diversified portfolio. But hey, if you’d rather tie your money up at one or two percent ROI, or lose your retirement in the market go ahead. Compare Demand Notes return for the last 24 mos. to any number of Wilshire, Russell, or S&P pegged funds and tell me which has weathered this storm better. How has your 401K done for the previous 24 mos? Demand Notes have returned a steady, consistent GAIN, compared to your 20-30% loss. You state that Demand Notes are “basically junk bonds”…do you even know what that means!? Should you sink your whole retirement into Demand Notes? Of course not. Should you avoid them like the plague, as the Auto Prophet here suggests? No. You should use them for the valuable tool that they are.
Good grief….this F’n guy….seriously. You wearing a mask right now so you don’t get “swine flu” chicken little?

The Auto Prophet said...

Looks like the GM finance guys are getting excited.

GMAC demand notes are paying high interest because they are trying to attract borrowers. They need to pay high interest because GM and GMAC have such a poor credit rating that investors with fiduciary responsibility (e.g. "investment grade" funds, banks, etc.) won't buy GM and GMAC unsecured debt. Hence the need for TARP.

Now, if professional investors won't buy the debt, we small guys should be careful about it, too. Chasing returns can be deadly, and decisions about returns should be balanced with one's apetite for risk.

Anonymous forgets rule #1 about investing, "prior results do not guarantee future performance".

I am telling people to be careful because many have used Demand Notes as a "money market savings" type vehicle, but it is not. I personally know people who think that these are safer than they actually are.

So let me amend my advice.

"Get out of Demand Notes unless you understand that they are not "safe" investments".

Anonymous said...

I have FIA and GMAC demand note accounts and have for many years. I keep all my liquid cash in these accounts and I have seen the stock market tank 50% while I have been making 4-6% on my money. A well diversified portfolio would have been down at least 30% in the past year. With all this talk about risk what about the risk of devaluation of the dollar? Do you think a paltry 1-2% return on your cash is going to save you from a depreciating dollar? I'll keep my money in these investments thank you! -THE VOICE OF REASON

The Auto Prophet said...

@Anonymous:
You are taking a lot of risk if all of your liquid cash is in these instruments.

By "diversified portfolio" I meant one appropriate for short term low risk money--that is, some short term government bond funds, some CDs, some money market mutual funds.

Anonymous said...

I have some $$ in Demand Notes because of the good return. Howeve, I see that Washington gave them a less than favorable analysis from the Stress Testing, saying that they needed to come up with about $11.5B in new capital to withstand any additional losses, should the economy get even worse. The $11.5B didn't account for any additional capital required from getting the Chrysler Financial responsibilities, either. I think I'm going to cash out all but enough to keep the account open. Once I see where the GM bankruptcy goes, I may reconsider and reinvest in Demand Notes.

Anonymous said...

To clarify my position I said previously that I had all my liquid cash in FIA and demand notes. I do have 50% in cd's right now paying 5% and I don't consider that liquid since I would never take the money out early and incur a penalty. I also have a stock portfolio mostly in oil and ng that pays dividends monthly. I believe it is important to have a high monthly income from cash and investments vs. stock appreciation during this downturn so you are not forced to sell stock at a loss. That being said I have left the minimum at GMAC and transferred the rest to the Ford Interest Advantage until all this bankruptcy talk is settled.

Anonymous said...

The federal government is going to give GMAC another 7.5 billion so they can finance GM and Chrysler cars. You may want to update this blog and change your opinion about the safety of GMAC demand notes since they now appear to be as safe as treasury notes but pay a 3.80% APY yield. This is exactly why me and other investors have stuck with them because we anticipated this outcome after they got 5 billion from TARP earlier in the year.