I would venture to say that there are two investment products people learn about before any others – Stocks and CD’s (Certificates of Deposit). Assuming most people learn about these two options when they’re young, I would think the way they were explained was elementary. Something like – stocks are risky – CD’s are risk-free.
When majority of people hear the term risk they think it’s the ability to lose money, which isn’t entirely true. It’s this risk-averse mindset that leads people to invest in CD’s.
There is something called inflation that typical
losers CD investors ignore. Inflation, of course, is the general rise in prices of goods and services over time. To oversimplify inflation, it’s why you can no longer buy a coke for 5 cents. To ignore this important economic factor is a huge mistake most people make.
The ONLY REASON you should ever be invested in a CD is because you need the money for something specific in less than 3-5 years. If you need it sooner, put it into your savings account. If you don’t need it for a while, invest in the stock market (not necessarily individual stocks). Historically stocks have proven to be the best hedge against inflation.
CD’s Make Me Laugh
I should take that back. I don’t actually laugh at CD’s themselves – they are an investing instrument that makes sense at times. Instead, I laugh at people who invest in CD’s for the fact that they are the epitome of hypocrisy. As I touched on earlier, most people place their money in CD’s because they are afraid to lose it (or because they are lazy); however, investing in CD’s nearly guarantees that you will lose money. Now don’t misunderstand this…a CD will not lose money as it is FDIC insured but you will lose purchasing power. What good is money that isn’t worth as much?
It is much more visible now that CD rates are extremely low – .4% for 11 months – but this has always been the case, even when CD rates were much higher.
Here is an example:
As the chart above highlights, CD’s have actually produced a negative real return (after tax & inflation) in 8 of the last 15 years. I might need to add it to my list of The 5 Worst Investments. To bring attention to another factoid presented by Invesco – if you were to invest $10,000 into 12 month CD’s for 15 years (ending 2010) taking taxes and inflation into account, you would be left with $9,821.
My advice: Don’t let your fear of losing money get in the way of building wealth.