Many people invest in CDs to reach their goals. Let me explain why I believe CDs are one of the riskiest savings tools for long-term investors.

When speaking with Christians about investments, I am amazed at how many own nothing but CDs. I believe that the reason so many Christians own only CDs is due to their nature. Christians by nature tend to be conservative. When investing, they often are uncomfortable with what we call "risk." Most people see CDs as no-risk investments. After all, the interest is guaranteed, right? This can be a major mistake! Let me explain why I believe CDs are one of the riskiest savings tools for long-term investors.

What is risk?

The problem most of us have is we use the word "risk" too loosely. Most of us think of "volatility" when we hear the word "risk." Volatility is the ups and downs that we see in the stock market. This is one type of risk. Because CDs do not have volatility, many people say they have no risk.

I like to define risk differently. Risk to me is the possibility of losing money in an investment. For short-term investors, volatility is the biggest risk you face. You should avoid volatile investments if you are investing for just 3 years or less. For long-term investors (3+years), volatility may be less of a factor. The biggest risk for long-term investors is often the combination of taxes and inflation.

Let me explain. If I told you that I had an investment that lost almost 1% per year on average over the past 75 years, would you like to own it? Of course not! That sounds pretty risky doesn't it? What if I told you this investment was a CD? Surprised? But you say, "CDs have guaranteed rates of return." Correct. But, we must take two things into consideration: taxes and inflation. The chart below shows the average return of a cash-type investment (such as CDs) from 1926 to 2001. The average return was 3.9%. The after-tax return was only 2.34%. Inflation for this period of time was 3.1%. In other words, you would have actually lost purchasing power by owning cash-type investments; -0.76% per year on average.

* Source: SBBI 2002 Yearbook, Ibbotson Associates 2002, p 31. Assumes combined marginal tax bracket of 40%.

Summary

Now you see why I feel CDs can be considered risky. They are good for some short-term situations, but may be highly overused if "risk" is defined improperly. If you have your long-term money invested in CDs or a money market account, it may be time to consider diversifying into other investment options, depending on your goals and investment objectives. If you would like us to help you with your portfolio, please contact us.

CDs offer a fixed rate of interest and are FDIC insured. Keep in mind that both the return and principal value of investments will fluctuate and may be worth more or less than their original cost when redeemed. Seeking a higher rate of return generally means accepting a greater degree of risk.