Will Investors Turn Away From CDs Forever?

The environment of ‘exceptionally low interest rates’ may help borrowers, but it has the unintended consequences of bringing real returns to zero or even negative if you consider the impact of inflation against nominal returns.  With rates being so low, it has taken the safe haven of the certificates of deposit down to negative real returns.

Bankrate.com has noted, “CDs have historically been popular investments for retirees and others seeking a high degree of safety. But rates have plunged in recent years: the average yield on a one-year CD has dropped from 3.77% in May 2007 to 0.34% today.”

0.34%???  Bankrate did not really need to bother noting that this rate of return is well below the rate of inflation. It is not even worth getting out of bed for or driving to the bank to make the CD purchase order.

To show just how bad 0.34% is in hard dollars, an investor putting $100,000.00 into a certificate of deposit can expect to earn a whopping $340.00 in interest for a year.  To tie up your money for this “return” hardly makes sense.  But wait, there’s more.  You also get to pay tax at the state and federal level on that $340.00.

So, this $340.00 as a reminder is just the average rate.  Bankrate.com shows that investors can make just over 1% for a one-year CD by going through MetLife, Ally, or CIT.  Investors can make as high as 1.74% to 1.8% if they are willing to go out five years.  That hardly covers the inflation rate, still giving a zero real rate of return.

Investors need to understand one reason that rates are being force-fed at such low rates. Some feel that the Federal Reserve is merely trying to encourage higher risk investing to support the economy.  There may be more to it like self-preservation.  If the Federal Reserve were to raise interest rates, then the cost of servicing the federal debt load would increase as well.

Even if the FOMC does start to raise rates before the end of the 2014 timeline, they are unlikely to raise rates very much.  Low CD rates and low rates on other investments may just be a part of the new normal.

JON C. OGG