Have you ever heard the idea that deciding to do nothing is still a decision? Well it is. And deciding to put your money in the bank at interest rates below inflation is like taking a loss. Choosing to be conservative has its own risks.
According to Kiplinger’s Personal Finance¹, the national average for 1-year CDs is 0.33%, while the average 5-year CD is not much better at 1.14% per year. Do you realize how little interest that is? On a $10,000 ‘investment’, 0.33% yields just $33 per year and only $330 on a $100,000 investment! As measured by the Consumer Price Index (CPI), inflation has averaged 2.49% over the last 10 years from 2002-2011.
Now I am not suggesting you forego all saving mechanisms. It still makes sense to maintain a cushion in a savings account, money market, or CD. Three to six months’ worth of living expenses is usually adequate. However, any money that you will not need for 12 months or longer can be put to better use.
Depending on your income tax status, you could consider tax-free municipal bonds or a bond mutual fund. Although they have received some negative press in the last few years, municipal bonds historically have a low default rate when compared with corporate bonds with the same ratings. A tax-free bond paying just 2.5% is equivalent to a CD (or taxable bond) paying 3.47% if your combined tax rate is 28% (some bond interest is exempt from both state and federal tax).
If you have a longer time horizon to invest the money, stock mutual funds may be a good option. Stocks are known for being a good inflation hedge, and at the moment, the federal long-term capital gains rate (for assets held at least one year) is just 15%. Also, if you happen to need the money back sooner than expected and the stock fund is sold at a loss, the decline in value may be used to offset other income or possibly lower your income tax liability.
Now is the time to stop losing ground to inflation and to make your money work as hard as you did to earn it.