EL SEGUNDO, CA, October 10, 2012 - The desperation for competitive interest rates today that will help grow savings without subjecting funds to stock market risk is leading many depositors to invest in long-term certificates of deposit. However, extremely long-term savings products like 10-year CDs may appear to offer better rates, but actually cause depositors to lose money.
Why 10-Year CDs Are Bad Investments
Competitive 10-year CD rates currently hover at about 2.10% APY. A person who deposits $10,000 into such a CD would accumulate a profit of $2,310 after those ten years, which may seem to be an appealing option to the timid investor who would rather take a smaller return in order to avoid any type of market risk.
However, a return of 2% APY may be considered high today, but 10 years from now that may not be the case. In fact, it could be terrible. The problem is that in order to obtain that interest rate now, a depositor would have to lock his or her money into a 10-year commitment, during which the interest rate remains fixed and access the money is prohibited.
1. Inflation Eats Interest
Depositors often don't factor inflation into their earnings. Ten years of inflation would significantly reduce the earnings on a 2% APY, if not wipe them out completely along with some of the principal investment.
2. Interest Rates May Rise in the Future
One of the positive characteristics of certificates of deposit is that they allow depositors to lock-in interest rates for the entire CD term. This positive, however, becomes a big negative when interest rates are already low — and the Fed has set the target rate to remain between 0 and .25% through 2015.
Locking in an extremely low rate now means account holders are stuck earning sub-par returns should interest rates increase in the future. Further, withdrawing CD funds prior to maturity in order to take advantage of rising rates would cause any interest gained to be lost to early withdrawal penalties.
3. Two Percent over 10 Years Is a Poor Return
Regardless of the rate of inflation or the Fed’s plans, earning 2% or less on a 10-year investment is a poor return. Investors would be better off putting money in an S&P 500 index fund such as the Vanguard 500 Index (VFINX).
Where consumers ultimately invest their money should be a decision based on goals – if the objective is to preserve savings in an FDIC-insured account, maintain some liquidity and earn enough interest to at least reduce the effects of inflation, a savings account or short-term CD is a good option. However, those looking to maximize returns over a decade or longer should stay away from low-yield deposit products and speak with a professional about moderate-risk market investments instead.
To view the complete article, please click here. www.gobankingrates.com