We all like guarantees…..right?

Interest rates on five-year certificates of deposit in the U.S. dropped below 1% for the first time on record (i.e., for the first time ever), according to Market Rates Insight. The national average rate for the five-year CD is 0.99 percent!

My colleague, Linda Patchett, commented on this blog a couple months ago about the long-term trend of interest rates in the U.S. and the fact that folks looking for “safe” income are struggling to find it in this low rate environment. That hasn’t changed and probably won’t over the near term.

That is a concern for us, but I would like to look at it from a slightly different angle - from one of “guarantees.” One of the main reasons Americans like to buy CD’s is because they are guaranteed to get their money back at maturity. CD’s are backed by banking institutions and then the FDIC, should something happen to the bank. So, assuming one is under the FDIC dollars limit, she/he will almost certainly get her/his money back at maturity and some interest along the way.

But the problem is that they will be nominal dollars, which are different from real dollars. Real dollars are adjusted for inflation. So, in today’s interest rate climate you would almost surely be signing up for a guaranteed loss in real dollar terms (since inflation is ranging between 2-3% per year right now). Depending on her/his situation (e.g., large consumer of food, health care or fuel), one’s personal inflation rate could be even higher.

For example, let’s say someone puts $100,000 into a five-year CD earning 1% and inflation averages 3% over the next five years. Five years from now that person would have around $105,000 (in nominal dollars) but they would have lost thousands of dollars of purchasing power. (This is because something that cost $100,000 five years prior would now cost about $115,000 due to inflation.)

We all like guarantees, but I certainly don’t like one that involves a guaranteed loss of purchasing power each and every year! Some might call that “going broke safely.”

If you have questions on this post or any other financial planning or investment management questions, please contact your Woodward Financial Advisors wealth manager. We are here to serve you.

Source: Market rates Insight and Bloomberg News