Nov 15, 2023
In this episode on Certificates of Deposit (CDs) as investments,we talk about the nuanced decision-making involved in purchasingCDs and whether or not CDs are good investments, particularly in arising interest rate environment, and we explain why interest ratesare the only factor you need to consider.
Wealth creation isn't solely dependent on CD rates, and we needto consider the impact of inflation and interest rates to gain acomprehensive financial perspective. The episode also explores howgovernment strategies to combat inflation by adjusting interestrates impact not only investors, but also shape the attractivenessof CDs as an investment option.
- In a rising interest rate environment, buying CDs may seem likea good idea but it depends on your needs and goals.
- Wealth isn't created by buying a CD based on a rate. It'screated by understandingwhy the rate may not be all that important.
- Banks look at what is known as the federal funds rate, alsoknown as a benchmark rate. This is the rate banks charge oneanother to borrow money overnight that's needed to maintain reserverequirements.
- Upstream in the decision making process is the Federal OpenMarket Committee or FOMC, who meet throughout the year to discussand set monetary policy. Within these policies, rates are set andtypically linked to inflation.
- When those rates are set, banks may adjust rates on loans,deposits and certificates of deposit. But just like any business,banks will adjust rates to compete in their market as they seek tocover their costs and maintain a profit.
- CDs specifically are an attractive tool for banks, becauseunlike a deposit account, CDs actually lock up customers with amaturity date, which gives banks better control of their cash flow.The higher rates draw in customers seeking to maximize theirreturns.
- Rates on CDs matter, but not as much when you factor ininflation and interest rates. If inflation is at 7% and interestrates are at 5%, the net is 2%. The same is true if inflation is at0% and interest rates are at 2%. You have to look at both numbersto get a full picture.
- When you consider the gridlock within the housing market andthe amount of debt our government holds, it's hard to believe ratescan remain elevated over the long term. The government isdesperately trying to combat inflation by raising rates.
- These higher rates not only impact consumers, but they alsoimpact the government. According to the Congressional BudgetOffice, or CBO, in June of 2023, they projected that annual netinterest costs on the federal debt would total $663 billion in 2023and almost double over the next decade. Interest payments wouldtotal around $71 trillion over the next 30 years, taking up to 35%of all federal revenue by 2053.
- These numbers are impacted by interest rates and with lowerrates come lower interest payments, so the government has reasonsto see rates lower than they currently are.
- The question is: Does it make sense to lock in CD rates whilerates are high? It depends. If you have money sitting in a bankaccount that you don't need and the CD rate is offering a higherrate than your savings, then it might be a good option.
- A good idea is to compare CD rates to other options like fixedannuities and money markets since they share some similarities butalso have a few key differences that could make one choice betterfor your situation.
- Certificates of Deposit are offered by banks as a savingsaccount that offers a fixed interest rate over a specified periodof time, ranging from one month up to five years. They carrypenalties if funds are removed before maturity, and they're FDICinsured up to $250,000.
- Fixed Rate annuities are issued by insurance companies and arefinancial products that offer a fixed interest rate over aspecified period of time. Early withdrawals can incur a penalty,and interest earnings are tax deferred until you start takingdistributions. The guarantees are backed by the claims payingability of the insurance company and are insured by what is knownas the State Guarantee Association.
- Money markets are funds issued by financial institutions thatare backed by highly liquid short maturity investments. Maturitiesusually range from overnight to just under a year, and assets canbe quickly converted to cash with minimal loss of value. They aregenerally considered more risky than a bank, CD or insurancecompany annuity, and the underlying investments include such thingsas treasury bills, commercial paper and CDs.
- While CDs offer the safety of fixed returns, they are notdevoid of risks and limitations. It's essential to understand boththe micro and macro economic factors that affect CD rates beforediving in.
Mentioned in this episode:
Common Sense Financial Podcast on YouTube
Common Sense Financial Podcast on Spotify
BrianSkrobonja.com/Resources - Free Resources ToHelp You Protect Your Financial Future
Common Sense: YOUR Guide toMaking Smart Choices with YOUR Money by BrianSkrobonja
“What to Know About How BanksWork”
References for this episode:
https://www.federalreserve.gov/monetarypolicy/reservereq.htm
https://fortune.com/recommends/banking/will-cd-rates-go-up
Investing involves risk, including the potential loss ofprincipal. This is intended for informational purposes only. It isnot intended to be used as the sole basis for financial decisions,nor should it be construed as advice designed to meet theparticular needs of an individual’s situation. Securities offeredonly by duly registered individuals through Madison AvenueSecurities, LLC. (MAS), Member FINRA &SIPC. Advisory servicesoffered only by duly registered individuals through SkrobonjaWealth Management (SWM), a registered investment advisor. Taxservices offered only through Skrobonja Tax Consulting. MAS doesnot offer Build Banking or tax advice. Skrobonja Financial Group,LLC, Skrobonja Wealth Management, LLC, Skrobonja InsuranceServices, LLC, Skrobonja Tax Consulting, and Build Banking are notaffiliated with MAS.
