Personal Finance Blog By MoneyRates - April 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.

Despite the pall cast over the stock market by the federal government's charges against Goldman Sachs, the past week has been highlighted by above-expectations earnings reports from JP Morgan Chase and Citigroup. This earning strength has been greeted as a sign that the big banks have really turned things around for the better. However, perhaps a measure of healthy skepticism is appropriate.

Looking at the earnings reports a little more closely finds that the latest numbers have been heavily buoyed by trading gains. Meanwhile, more fundamental business lines (i.e., retail and lending) are ailing.

Haven't we seen this movie before? Trading gains reflect the type of activity that can just as easily work against a firm, as was demonstrated during the financial crisis. In the current environment, these trading gains come from a period that has seen a roaring stock market recovery. Heavy trading gains in a bull market can simply be a sign of risk-taking and leverage -- not the fundamentals on which sound banking is built.

There is an old investment adage -- don't mistake a bull market for brains. Until banks can show earnings strength based on fundamental banking business lines, they won't have demonstrated that they are on the path to sustainable success.

This matters for bank rates because the more profitable banks are, the more they will pay in the form of savings account rates, money market rates, and CD rates to attract deposits. Thus far, the fact that bank rates have yet to respond to the improved profitability of some big banks may reflect the banking industry's own doubts about how sustainable those earnings are.

Perhaps you've heard the news that investment bank Goldman Sachs has been accused of fraud.

The accusations revolve around a young trader at Goldman Sachs who had the clever idea to package subprime mortgage-backed securities, sell those "assets" to Goldman Sachs clients, and then at the same time, short (bet against) those assets on behalf of Goldman Sachs. You know, one of those "heads I win, tails you lose" kinds of deals.

The accusations of fraud, it's worth noting, pertain to Goldman Sachs not disclosing this strategy to the clients it was selling the junk assets to. Actually selling the assets and then betting against them is not illegal at all.

Meanwhile, on the very same day--and the timing appears far from coincidental--allegations emerged yesterday that the SEC suspected fraud was being committed by now-indicted money manager Allen Stanford as early as 1997.

But the SEC did nothing until 2006. By then, Mr. Stanford had defrauded more than 21,000 people by selling questionable certificates of deposit from a bank in Antigua.

Yes, low bank rates on FDIC-insured CDs, money market accounts, and savings accounts can cause frustration. And yes, savings investors have ample reason to feel like the banking system needs to treat savers better.

But no, as yesterday's news proves beyond the shadow of a doubt, having a low rate on an FDIC-insured, guaranteed return CD is most definitely not the worst thing the investment world has to offer.

Jamie Dimon of JP Morgan Chase was recently named "Banker of the Year" by American Banker magazine.

Author Simon Johnson, meanwhile, has been vehemently calling for the giant banks to be forcibly broken up. Of late, Johnson has been taking particular aim at Chase and Dimon.

For people who are trying to get higher interest rates on CDs, money market accounts, and savings accounts, it's tempting to side with Mr. Johnson and outright root for Chase, Wells Fargo, B of A, and Wells Fargo to receive the AT&T treatment, and be broken up into itty bitty pieces.

Wouldn't more competition between banks for deposits naturally drive up interest rates on CDs, money market accounts, and savings accounts? After all, the Big 4 Banks hold about 40 percent of total deposits as of now--this type of dominance while paying offensively low deposit rates.

Would a break-up of Chase Bank automatically correlate to higher interest rates on CDs, money market accounts, and savings accounts?

Not necessarily, but if you haven't been following Simon Johnson's arguments as to why humongous banks are bad for savings investors, it may be time for a trip to www.13bankers.com.

The guy makes some solid points, and has a British accent.

There are perhaps a dozen or so names that quickly come to mind as giants of the banking industry. In years past, you might have instinctively turned to one of these giants anytime you were looking for a bank. However, the financial crisis has made many people re-think the benefits of choosing a large bank, and new FDIC rules may give you yet another reason to give smaller banks a closer look.

The FDIC is considering special measures for the 107 banks whose assets top more than $10 billion. These measures would determine how FDIC insurance premiums are calculated, and could result in higher premiums for large institutions which engage in riskier behavior.

107 banks may seem like a large number, but considering that there are roughly 8,000 institutions covered by FDIC insurance, that 107 really represents a select group of the largest banks.

FDIC insurance doesn't necessarily affect savings account rates, CD rates, or money market rates, but it can be a factor. Banks make money off the spread between what they have to pay to attract deposits (i.e., bank rates) and what they can make by investing or lending that money. The higher the overhead costs of a bank, the more they need to improve that spread to offset costs. Lowering bank rates on deposit is one way of raising the spread.

If the FDIC insurance burden becomes greater on larger banks, as a group they may offer less attractive bank rates. Of course, there are other things that affect bank rates, but this is a reminder to keep an open mind when shopping for a bank. You may have to look beyond the household names to find the best bank rates.