One of the main topics in financial news these days has been the significant rise in interest rates over the past two years. It was not too long ago that many investors were frustrated by low yields on “ultra low risk” investments such as money markets, CDs and U.S. treasuries. In an effort to seek better returns, many investors chose to invest in the stock market, even if they were somewhat uncomfortable in doing so.
So what about now, with yields significantly higher than they have been in recent memory? At Harris Financial Group, it seems like we have had more discussions with clients about topics like CDs and treasuries in the past 6 months than in the prior 20 years combined!
“Are CDs and treasuries risk-free?”
One of the questions clients often ask is: “Are CDs and treasuries risk-free?” But such a simple question has a complicated answer.
In terms of the risk of an investor’s capital, CDs and treasuries represent a very low degree of risk. Investors have the option of purchasing CDs with FDIC protection (up to the relevant FDIC limits) or treasuries backed by the full faith and credit of the United States government. So from that standpoint, most investors feel very comfortable with the relative lack of risk on their capital.
But could there be other, less obvious risks to consider?
The first risk is based on another topic in the news lately: Inflation. Hypothetically speaking, let’s assume a 12-month CD yields 5%. Many investors see that 5% nominal yield and find it very attractive. And it might be a suitable fit, based on an investor’s risk tolerance, goals and time horizon. But what if inflation is at 6% over that same 12-month period? That means an investor could lose 1% of purchasing power on their money over the term of the CD.
Another risk to consider is Reinvestment Risk, which is the possibility that an investor will not be able to reinvest the principal and interest of their current investment into a new investment at comparable terms in the future. For example, what if the investor who opted for the 12-month CD at 5% can only find a rate of 2% when the CD matures?
Neither the risk of losing purchasing power nor reinvestment risk are, by themselves, reasons to avoid investments like CDs and treasuries. These are, however, factors that every investor should consider when making a decision about whether to consider CDs and treasuries.
If you would like to discuss this topic further with us, or if you would like us to review your current investment portfolio with you, please contact us at 800-281-3980.
All investing involves risk including loss of principal. No strategy assures success or protects against loss.