Safe But Sour CD Symptoms

Bank Certificates of Deposit (CD's) have traditionally been among the lowest risk investment tools possible. They are safe because they are insured against loss of principal by the Federal Deposit Insurance Corporation (FDIC) up to an initial deposit of $100,000 per institution. Compared to the rest of the realm of investment tools, they also usually offer the lowest rates of return. Not only is rate of return low, but the interest earned by a CD is taxable annually as regular income. A CD owner receives an IRS Form 1099 which reports the interest earned. This amount is then included on line 8a of the Federal Form 1040.

In addition to considering low returns, subject to taxes, investors must also consider the inflationary environment.

Inflation always decreases the overall return on investment. Interest earned is further eroded by the effect of taxes. Depending upon your personal tax situation, it is highly likely you are actually losing money by having too much invested in CD's.

In many cases, investors have a tendency to want to keep most of their money liquid. Most think they will need it on short notice. Banking studies have shown that the average life of a 90-day CD is actually 5.4 years. Though the CD matures every 90 days, the certificate is continually renewed, unless other instructions are given. These studies demonstrate that the need for liquidity is much less than most holders perceive. Certificates of Deposit were intended to be short term instruments providing a greater return than completely liquid accounts such as savings or checking. Risk management and limited liquidity are part of this equation. But four critical criteria must determine the wisdom and overall performance of any investment. These four are: Rate of return, Tax impact, Inflation, Time invested

The design of a Certificate of Deposit means the rate of return is fixed for the life of the contract (time invested). The Certificate owner normally has no direct control over the inflation rate and, with this investment, has no control over how he/she wants the earnings taxed.

A typical ad for a CD would read: 90 Day CD at 4.0 or 180 Day CD at 4.25 or something similar. Certificates of Deposit are designed to be short term instruments. Far too many investors are putting money into these tools over the long term. Their returns will suffer the consequences of a limited investment view.

Simone J. Nathan

Author of Going for Gold After 50: An Illustrated Guide to High Probability Investing

[http://www.goldafter50.com]

[http://www.goldafter50.blogharbor.com]

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