Criticism
CD interest rates closely track inflation. For example, in one situation interest rates may be 15% and inflation may be 15%, and in another situation interest rates may be 2% and inflation may be 2%. Of course, these factors cancel out, so the real interest rate is the same in both cases.
In this situation, it is a misinterpretation that the interest is an increase in value. However, to keep the same value the rate of withdrawal must be the same as the real rate of return, in this case, zero. People may also think that the higher-rate situation is "better," when the real rate of return is actually the same.
Also, the above does not include taxes. When taxes are considered, the higher-rate situation above is worse, with a lower (more negative) real return, although the before-tax real rates of return are identical. The after-inflation, after-tax return is what's important.
It is a common belief that, "You don't make any money in bank accounts (in real economic terms), simply because you're not supposed to."; on the other hand, bank accounts and CDs are fine for holding cash for a short amount of time.
However this applies only to "average" CD interest rates. In reality, some banks pay much lower than average rates while others pay much higher rates (differences of 100% are not unusual, e.g., 2.50% vs 5.00%). In the United States, depositors can take advantage of the best FDIC-insured rates without increasing their risk. Furthermore, a long-term CD might have a high nominal interest rate with a relatively low real interest rate due to high inflation at the time of purchase (as indicated above); however inflation rates often change rapidly and the final real interest rate could be significantly higher than riskier investments.
Investors should be suspicious of an unusually high interest rate on a CD. Allen Stanford used fraudulent CDs with high rates to lure people into his Ponzi scheme.
Finally, the statement that "CD interest rates closely track inflation" is not necessarily true. For example, during a credit crunch banks are in dire need of funds and CD interest rate increases may not track inflation.
Read more about this topic: Certificate Of Deposit
Famous quotes containing the word criticism:
“Unless criticism refuses to take itself quite so seriously or at least to permit its readers not to, it will inevitably continue to reflect the finicky canons of the genteel tradition and the depressing pieties of the Culture Religion of Modernism.”
—Leslie Fiedler (b. 1917)
“The critic lives at second hand. He writes about. The poem, the novel, or the play must be given to him; criticism exists by the grace of other men’s genius. By virtue of style, criticism can itself become literature. But usually this occurs only when the writer is acting as critic of his own work or as outrider to his own poetics, when the criticism of Coleridge is work in progress or that of T.S. Eliot propaganda.”
—George Steiner (b. 1929)
“People try so hard to believe in leaders now, pitifully hard. But we no sooner get a popular reformer or politician or soldier or writer or philosopher—a Roosevelt, a Tolstoy, a Wood, a Shaw, a Nietzsche, than the cross-currents of criticism wash him away. My Lord, no man can stand prominence these days. It’s the surest path to obscurity. People get sick of hearing the same name over and over.”
—F. Scott Fitzgerald (1896–1940)