Comparing CD Rates to Rates of Return On Other Investments Can Be Tricky
April 20, 2010
One fundamental fact about investing that affects all investors is the idea of allocation. In simple terms, when you put your money into one investment, that's money that cannot be put into another investment.
When you're investing in CDs, this either/or, black/white choice becomes even more stark. Especially if the stock market is going up as it has been for the past year, the temptation to move from CDs to stocks can be strong.
However, it's vital to compare not only the percentage yield of each investment over a period of time, but also the degree of risk involved in each investment.
CDs entail basically no risk, so long as you stick under the $250,000 limit for FDIC insurance; the government has shown that it will take heavy measures to protect bank depositors against loss of capital. Stocks, by contrast, have proven very volatile and subject to decline.
Apples and oranges can be compared, but not with complete accuracy, and it is the same thing with CDs versus stocks.
CD investors must, then, always use as part of the calculation of the real rate of return the fact that CDs do not result in exposure to loss of principal, whereas stocks potentially do.
This is an obvious point but also one that must always remain in plain sight, when comparisons of investment returns are under the microscope.