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:
“Parents sometimes feel that if they don’t criticize their child, their child will never learn. Criticism doesn’t make people want to change; it makes them defensive.”
—Laurence Steinberg (20th century)
“The aim of all commentary on art now should be to make works of art—and, by analogy, our own experience—more, rather than less, real to us. The function of criticism should be to show how it is what it is, even that it is what it is, rather than to show what it means.”
—Susan Sontag (b. 1933)
“In criticism I will be bold, and as sternly, absolutely just with friend and foe. From this purpose nothing shall turn me.”
—Edgar Allan Poe (1809–1845)