People choose deposit accounts, such as savings accounts, certificates of deposits, and money market accounts because they want to avoid risk. However, risk comes in many forms, and one risk these accounts are open to is interest rate volatility. With signs that a new round of interest rate volatility may be on its way, this may be a good time to review interest rate risk.

Historical Perspective on Interest Rate Risk

To illustrate interest rate risk, think of a 1-month CD as an example. As long as it is covered by FDIC insurance, the principal value of that CD is in no danger. However, what can fluctuate wildly is the expected return.

Back in December of 1980, 1-month CD rates peaked at 19.24%. This means that if you had a $100,000 CD, you would earn a hefty $19,240 in just one year if that rate held. Of course though, that rate didn't hold, and since short-term CDs have to keep rolling over at a new interest rate, they run the risk of reinvesting at a lower rate. In just two years, that rate dropped to less than half of where it had been, to 8.64%. This would translate to an annual return on $100,000 of $8,640.

Flash forward to 2009, and by April, 1-month CD rates had fallen to 0.4% -- representing just $400 a year on $100,000. So, while the principal was safe, the expected return had fallen sharply, from $19,240 in 1980 to $400 in 2009.

The Current Situation

Recent action in the Treasury bond market suggests interest rate volatility is stirring up again. The good news is that bond yields have been moving higher, and with CD rates so close to zero, it certainly seems they are more likely to rise than fall. This is food for thought in choosing the term for a CD, and if interest rates do rise, its a good reminder to lock up higher rates a little longer when they are available.