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Bank Rates Have an Unlikely Competitor in Stock Dividends

February 11, 2010

| MoneyRates.com Senior Financial Analyst, CFA

An indication of just how extraordinarily low bank rates are these days can be found in an unusual place: the stock market. It may be that low bank rates--or low interest rates in general--have helped to drive the stock market's strong rally over the past year.

Under normal economic circumstances, bank rates offer reliable income, while stocks offer less income in exchange for growth potential of the asset. In late 2008, however, that relationship changed drastically, which may have made stocks look much more appealing to many investors than deposits over the past year.

CD Rates and Dividend Yields

The income component of stocks comes from dividends. To compare the income component of deposit accounts with that of stocks, MoneyRates.com looked at 1-month CD rates and the dividend yield of the S&P 500.

As one might expect, over the past 20 years, 1-month CD rates have averaged more than twice the dividend yield of the S&P 500, and rarely did that dividend yield ever exceed 1-month CD rates. However, by the end of 2008, a combination of rising dividend yields and falling bank rates meant that 1-month CD rates dropped below the S&P 500 dividend yield--far below. As of December 31, 2009, the S&P 500 dividend yield was nearly four times the 1-month CD rate.

The Relevance of CD Rates to Dividend Yields

This comparison is relevant in two ways. First, it is an example of how low interest rates generally make stocks more attractive. This helps explain why, despite only a shaky signs of improvement in the economy, the S&P 500 gained more than 20% in 2009.

Second, it is a reminder that income seekers do have alternatives. While stocks have extreme ups and downs, if you are investing primarily for income, you'd find stock dividends are much more stable than stock prices--in fact, they've even been more stable than bank rates. In short, until bank rates rise, banks are going to lose potential depositors to other alternatives, even those with higher risk.

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