Will CDs Make a Comeback

According to the Wikipedia definition: A certificate of deposit (CDs) is a time deposit, a financial product commonly sold in the United States and elsewhere by banks, thrift institutions, and credit unions.

CDs were in vogue during the 1980s in the U.S. because they were perceived to be extremely stable investments that rode the wave of high interest rates common at the time. It wasn’t  unusual to earn 10%-15% interest for one-year CDs. In times of high inflation and high interest rates, low returns from other investments made CDs attractive for investors who wanted to preserve their base capital or at least minimize loss during times of great uncertainty.

What is a CD?

A CD is a deposit to a bank with an agreed upon return over a certain period of time. During the late 1970s and early 1980s, investors rushed to instruments that could generate income, especially because equity markets were depressed at that time.  The return rates on CDs can sometimes track closely to the inflation rate which provides a way to, at the very least, somewhat preserve capital during inflationary times. If rates drop during the life of the CD, returns can be reasonable.  However, it is always imperative to examine the real rate of return on a CD or any other investment for that matter.  Real rate of return is the return on the investment, less the inflation rate and the taxes paid on the return. See Chapter 22 of my book and watch the accompanying video “Do You Really Know What Your Investments Earn? The Secrets You Need to Know” for more information.

When they are good

CDs can work well for investors who are willing to tie their money up for longer periods of time and accept a generally lower rate of return than might be available with other investments. The higher the amount of the deposit, generally the better the rate. A five-year CD initiated near the top of the interest rate cycle with a large sum can be an excellent play for the risk averse. The trick here is to know for sure when the top of the interest rate cycle really is.

The Bad

CDs are only slightly better than a standard savings account during times of low interest rates. One of the greatest risks for a CD is to be locked into a particular rate for extended periods of time resulting in loss of opportunity to invest in other ways if financial markets have moved into a more favorable environment. Rising rates can  also be a problem because you are locked into a lower rate and can lose out if new rates would be more favorable to you..

With interest rates rising, could CDs make a comeback?

It’s not likely that CDs will regain the popularity they had in the 1980s or at least anytime soon. Current interest rates are so low that the time horizon for any significant return on a CD may not be that attractive.

It is important to remember that CD return rates track inflation closely so the perceived gains can be an illusion when you consider all the factors in calculating the real rate of return. We currently have very low interest rates that may only rise gradually for the foreseeable future. Inflation is also quite low, at least for now. There are many other investment options available now that would yield far better returns than CDs. The interest rate environment will have to change a lot from where it is now  to make CDs attractive once again.

Disclosure: Investing involves risk, including possible loss of principal, and investors should carefully consider their own investment objectives and never rely on any single chart, graph or marketing piece to make decisions. The information contained in this piece is intended for information only, is not a recommendation to buy or sell any securities, and should not be considered investment advice. Please contact your financial adviser with questions about your specific needs and circumstances.

The information and opinions expressed herein are obtained from sources believed to be reliable, however their accuracy and completeness cannot be guaranteed.  The opinions expressed herein are those of the author and not necessarily those of United Capital.  All data are driven from publicly available information and has not been independently verified by United Capital. Opinions expressed are current as of the date of this publication and are subject to change. Certain statements contained within are forward-looking statements including, but not limited to, predictions or indications of future events, trends, plans or objectives. Undue reliance should not be placed on such statements because, by their nature, they are subject to known and unknown risks and uncertainties.