Q: I see the stock market and real estate are improving every day, so why do we still see these ridiculously low rates on CDs and savings accounts? Are those rates going to improve soon, or do we have to put our money into the stock market?
A: You've put your finger on the Catch-22 facing investors these days: Low interest rates are driving investors into stocks, but if stock prices go up solely because interest rates are low, those stock prices may be vulnerable when interest rates start rising.
A look at the numbers reveals why this dilemma is so tough. Over the past three years (through April 30, 2013) the S&P 500 stock index rose at a rate of 12.8 percent per year. More recently, home prices have been recovering, and have risen by about 9 percent since hitting bottom early last year.
Meanwhile, rates on savings accounts and other deposits seem stuck in the mud. As of the end of April, the average savings account interest rate was just 0.06 percent, which is even lower than savings account rates were three years ago. It's only natural that investors should be looking to stocks and other risky investments as an alternative.
The problem is that while stock prices are up, the overall economy has made only sluggish progress. This suggests that stocks are up primarily because investors lack for better alternatives, and that's a shaky foundation on which to build a market rally.
So what are you to do in this situation? It's probably best not to look at it as an all-or-nothing proposition. You might incline a little more toward stocks in this environment, but that doesn't mean you should cash in your savings accounts and put every penny into the stock market.
Before taking on more stock market risk, ask yourself these fundamental questions:
- When are you likely to need this money? If you'll need a substantial portion of the money within the next five years or so, stocks may not be an appropriate investment.
- Do you have a sufficient emergency fund? This would help you avoid having to cash out of stocks at an inopportune time.
- Are you emotionally prepared for the ups and downs of the stock market?
As for the money you keep in deposit accounts, while there are no signs that interest rates are going to rise anytime soon, there seems little point in locking yourself into a long-term CD at today's rates. Keep your money flexible by concentrating on short-term CDs, money market accounts or savings accounts. It's hard to say when rates will rise, but you want your accounts to be able to react quickly when they finally do.
Got a financial question about saving, investing or banking? MoneyRates.com invites you to submit your questions to its "Ask the Expert" feature. Just go to the MoneyRates.com home page and look for the "Ask the Expert" box on the lower left.