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Advantages and pitfalls of CDs

By Sheyna Steiner · Bankrate.com
Wednesday, May 19, 2010
Posted: 4 pm ET

CDs are a savings rate investment that make people feel good. Like a bond they have a coupon and maturity but unlike bonds they are understood by nearly everyone who invests in them.

That's one aspect that makes them very attractive. Besides their simplistic design, the FDIC guarantee makes them a sweet deal for risk-averse investors.

But, in the current market, their simplicity and government-backed guarantee to principal come at a high cost. CD rates stink right now and it's expensive, in terms of opportunity costs, to tie your money up in an investment that doesn't provide a reasonable rate of return.

"When an investor looks at an investment they should always look at the risk -- return scenario, the risk -- return scenario for CDs is minuscule. If there is any type of inflation, which has been highly forecast, and, is being orchestrated by every central bank in the world right now,  you're going to lose money in real terms," says Bill Larkin, fixed-income portfolio manager at Cabot Money Management.

Buying at today's yields could lead to losing purchasing power down the line but to get more yield investors have to get into bonds.

"Many of the corporate bond investments, short-term, high-grade, have done very well and the returns are two to three times (that of Treasuries and CDs) so if you look at the risk that is a risk worth taking in this market," Larkin says.

"The investor that invests in CDs is very scared and they are willing to pay a very high premium for the return of their principal," he says.

What do you think? Are you sticking with CDs or have you taken on more risk while waiting for interest rates to rise?

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7 Comments
Linda Kocher
May 26, 2010 at 1:46 pm

I have always been a big invester in CDs. Unfortunately, all of my CDs (some that I had for as long as five years) are maturing this year. I have found that most of the banks have Savings Accounts that are currently paying better than short-term CDs. I received 1.35% this morning with a 10% bonus on the interest earned each 3 months. Short-term, this is a good solution.

Sheyna Steiner
May 26, 2010 at 1:27 pm

@Adrienne Though investing in CDs alone would not help me meet my investing goals, thanks in part to a slightly lackluster savings habit, if its working for you and helps you sleep at night then it must be good for you. I've been told that the rate of return is not quite as important as how much you save, though I suppose it all depends on your perspective.

Sheyna Steiner
May 26, 2010 at 1:24 pm

@M.M. 1.29 percent is certainly a lot better than you can do on many 6-month CDs these days.

Thanks for reading and writing!

Adrienne Marshall
May 26, 2010 at 1:13 pm

I totally agree! I got out of the stock market years ago and went to CD's. The tortoise and the hare syndrome and I am well pleased. Slow and save, a little vs nothing! While friends and neighbors suffered their losses, my CD' kept plugging along. But when all is said and done, for me it is "IN GOD I TRUST".

M.M. Klauberg
May 26, 2010 at 9:49 am

We are hedging our bets by putting more money into cash these days while continuing to dollar cost average into stock and bond funds. Our "cash" choices are very short (6 month) jumbo CDs (100k) and online (Ally Bank) savings accounts which pay 1.29%, no fee. If I had known about Ally's rate before I put 100K into the CD, I probably would have it all with Ally (up to 250K for FDIC protection).

Expecting another market correction but hoping for the best....

Sheyna Steiner
May 25, 2010 at 2:14 pm

Good point, it is better to make a little than lose a lot and plenty of people are happy to sit out the volatility, particularly if they're betting that there's more bad news around the corner. And many are betting that as evidenced by last week's Treasury yields which were at a five month low.

I'm so curious why you say that precious metals are not high risk. Indeed they don't pay interest or dividends and are generally not correlated to other asset classes but my understanding is that precious metals, gold and silver in particular, can be rather volatile at times and then stagnant.

Thanks for reading and writing!

Stacy Richardson
May 25, 2010 at 12:59 pm

Although CD rates are almost unfathomably low right now, I'd rather make a little money than lose a LOT of money. And in this environment, I think stocks and commodities are much more likely to go down than up.

In fact, I expect a stock-market crash this year, if it's not already happening.

The only investments I do NOT see as a high risk involve precious metals. But gold and silver don't pay interest.