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Client Conversations: What’s the Real Return on CDs?

February 2018

Certificates of deposit may seem like a smart way to save, but the real return may be lower than you think.

Client Conversations gives financial advisors an easy way to communicate with clients on topics influencing financial markets; it highlights common investor behaviors and offers ways to address the challenges investors face. Share this article with your clients, and remember to follow your firm's policies that govern sharing content with clients and prospects.


The real return on CDs is a lot lower than you may think

Low interest rates make life difficult for people who save their money or rely on their investments for income. 6-month CD rates have been below 1% since 2009, and they were just 0.27% at the end of 2017. When you factor in taxes and inflation, 6-month CDs have provided negative real returns 16 out of the last 30 years and haven’t offered a positive real return since 2008. 

 

How Inflation and Taxes Have Affected CD Return Rates

 

CCWP011_1

Data Source: Morningstar, Inc., 1/18

Past performance does not guarantee future results.

 

Certificates of Deposit (CDs) are short-term investments that pay fixed principal and interest, are insured by the FDIC up to $250,000, and are subject to changing renewal rates and early withdrawal penalties. The tax rate used in the example is the highest marginal federal income tax rate based on $100,000 of taxable income for a married couple filing jointly. The tax rate is not representative of the experience of every investor, and a lower tax rate would have a favorable effect on the real return.

 

Are CDs the Right Choice for You?

Although there are benefits to investing in CDs, there are also risks. Because of the inherent safety and short-term nature of CDs, the interest rate is usually lower than investments with higher risk. In addition, CDs sold prior to maturity may be subject to early withdrawal penalties. Investors should also consider the impact of inflation on CD returns. CD income in the illustration below is calculated using the six-month annualized average monthly CD rate.1

 

Inflation Eroded More Than Half the Return of CDs Over the Past 30 Years

This chart illustrates the growth of a hypothetical $10,000 investment in 6-month CDs before and after inflation from December 31, 1987 to December 31, 2017. Inflation consumed 80% of the return that CDs provided over this period. (Inflation is measured by the Consumer Price Index.)3

CCWP011_2

Data Source: Data Source: Morningstar, 1/18. From 12/31/87-12/31/17, the average annual return for six-month CDs was 3.69%; the average annual return for Inflation(Consumer Price Index) was 2.56%.

 

Talk to your financial advisor today about investments
with the potential to outpace taxes and inflation

 

Client Conversations gives financial advisors an easy way to communicate with clients on topics influencing financial markets; it highlights common investor behaviors and offers ways to address the challenges investors face. Share this article with your clients, and remember to follow your firm's policies that govern sharing content with clients and prospects.


 

1 CD rates are reported by the Citi Certificate Of Deposit 6 Month Index.
2 Highest marginal federal income tax rate based on $100,000 of taxable income for a married couple filing jointly, www.taxpolicycenter.org
3 Inflation rates are based on the Consumer Price Index (CPI), a measure of change in consumer prices as determined by the U.S. Bureau of Labor Statistics. You cannot invest directly in the index. 

All investments are subject to risk, including the possible loss of principal.

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