What is great for the bank might be lousy for the individual. Let me explain.
In 1961, the transformed the banking system in America. By offering this time deposit investment option to the public, banks were able to raise large amounts of money. With a guarantee to pay the investor timely interest owed and principle at maturity, Americans purchased billions of CDs and by 1966, the certificate of deposit had raised over and became the second largest investment holding behind Treasury bills.
Today, according to BankRegData.com, over $54.4 trillion were invested in CD’s in 2018.
Because of the need to instill confidence in the banks during the Great Depression, the FDIC began insuring deposits back in 1933. Today, that CD can be FDIC insured up to $250,000 per bank.
As attractive as the insurance may be, the result for the individual can actually hurt purchasing power. Additionally, because this money was not invested in growth investments, the “opportunity lost” also hurts the investor.
When my mother was 43, she was divorced after 22 years of marriage and five boys. I remember clearly asking her what she was going to do with her half of the settlement. She answered that she was not going to make any decisions and said, “I’m just going to put the money in the savings and CDs at the bank.”
Well years later, I realized this was a decision, and it was not a good one. My mom had tripped herself down a path of becoming an old lady on a fixed income.
Here is why you shouldn’t make this same mistake.
Bankrate.com tracks deposit rates and reports that the one-year average CD rate is 0.88%. (as of February, 2019). [If you search, you can find CD’s that pay more. But most CD buyers let it “ride” when their CD matures, to be invested at the average rate in years to follow. In fact, banks are counting on that!]
If you invest $100,000 in a one-year CD at the average rate of 0.88%, you will earn $880 after one year. If you are in the 24% tax bracket, you will pay $211 in taxes leaving you with a gain of $669 and an account balance of $100,669.
InflationData.com reports that inflation for the year 2018 clocked in at 2.44%. This would require your $100,000 at the beginning of the year to increase in value to $102,440 by year’s end – just to stay even with inflation!
If you invested your money in a one-year CD, then you were $1,741 under water. (The needed $102,440 - $100,669 earned = $1,741.) This is why many call them Certificates of Depreciation.
This is devastating news to those who buy CDs.
Many women, like my mom, will default to the “safe” and “insured” investment of the Certificate of Deposit. Unfortunately, this decision will likely lead that investor down the path of losing purchasing power, and being on a fixed income, that doesn’t even keep pace with inflation.
When banks receive CD money, they pay investors the stated interest rate. But we all know that they lend this money to businesses, Credit Card holders, home buyers (through their mortgage) and others who borrow this money at a much higher rate than they paid you. The CD is a great money maker for the bank, but a deflator for the investor – who is in jeopardy of losing purchasing power.
Some important reasons exist to consider having money that will be spent in the short-term in a CD. However, for money that is not going to be used for years to come, better investments (and many are also insured) can ensure you beat inflation.
Work with a professional who can help you create a well thought out financial plan so that your money works for you (and not the bank) and is best positioned to outpace inflation.
This can lead to many happy years to come!
Shak Hill, CFP®, CLU®, ChFC® is a graduate of the United States Air Force Academy and is the headmaster of Guiding Light University, whose sole mission is to Financially Empower Women. Learn more, click here.