Family Life Financial Services Inc. - Greater Lansing Financial Services

Going Broke Safely
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Many conservative investors look for safety with short-term certificates of deposit (CD’s), which are issued at most banks and federally insured by the FDIC. While CD's do ensure safety of principal, a few important factors should be taken into consideration before allocating a large portion of one's portfolio in them.

First, in periods of very low interest rates, investors should know that this lowers the guaranteed return rates that banks can place on savings accounts and CD's. Secondly, CD's, unlike annuities, have no special tax advantages so earnings from them are calculated on an annual basis. If an investor is currently earning the current average of 1.4% in a one-year certificate of deposit is taxed by the IRS at the national average income tax rate of 30%, the actual rate of return on the CD reduces to less than 1%. As always, investors should check with their tax professional before entering into any contract that offers tax-deferral.

Finally, inflation rates must be taken into consideration when determining the actual rate of return on a CD. Inflation is the general rise of the price of goods and services in an economy over time--it ebbs and flows with the strength or weakness of the economy and the general money supply. The average inflation rate for the months of 2010 was around 1.5%; if we use national averages to come with our previous number of .98% of earnings in a one year CD, that same investor would actually lose purchasing power when inflation is taken into consideration, almost a half percent on their money.

CD’s are a great tool for providing safety of principal. But, as with any other investment, they should be carefully considered and reviewed with each individual’s financial planner and tax professional.