16% Annual Rate CD??


photo by Greg Jordan, Copyright 2013

Many of you reading this might remember, and some of you are too young, but there was a time when you could walk into a bank and plunk down $10,000 into a Certificate of Deposit (CD) paying 16% per year. There was also a time when you could purchase a 30-year Treasury bond issued directly from our US Treasury that paid 15% annual interest guaranteed!!  The time frame of these exorbitant rates were the late summer and early Fall of 1981.  Oh, if only we had some cash and a time machine!  Hmmm, there are some other things I would do differently then too.

So now that CDs and Government bonds are paying relatively (and historically) low interest rates, why did they change so much?  The answer, in simple terms, is “inflation.”  Inflation is the increase in price of goods that you purchase on a daily basis.  This “basket of goods” contains items such as clothing, shoes, fruit, meat, financial services, furniture, and other consumable items.  Inflation is also the culprit of diminished purchasing power…or the ‘affordability’ index of your dollar.

During these periods of high inflation in the early 1980s, interest rates on mortgages were as high as 16%.  Savings accounts were paying 9%.  Auto loans were charging 18%.  And income (salaries and wages) had to increase at annual rates of 10% for several years just to keep up!  In other words, it was all relative to the risk adjusted Real Rate of Return where an investor assumes some risk beyond those of the guaranteed government bonds.

So now that CD rates are starting the slow climb back up from near 0% (1-year CDs were paying 0.3% on average in October 2012 according to Bankrate.com), it doesn’t necessarily mean that you are making more money relative to the increase in the cost of goods.  In other words, the returns you are getting go towards paying the additional costs due to inflation.

If you’re looking to invest some money in “something” that offers a potential better return than CDs, please schedule a personal appointment with me.  There, I can help you understand the relationship between risk and reward on a variety of investment options, and how inflation affects the purchasing power of your dollar now, and potentially in the future as well.