Interest rates are dropping, and if analysts are right they will continue to drop all year long. If you are borrowing money, or if you have considered borrowing, this is a good trend. But if you are investing, or worse yet, using investments for income, this trend could be damaging.
Specifically, the investments that are being effected by dropping rates are savings accounts, money markets, bank CD’s, and bonds. The stock market option may be appealing, but only if you have the time horizon to weather out bad economic times.
It only makes sense to seek out the best possible rate for the longest possible term in an environment like this where rates are declining. Investing in CD’s, although the rate is fixed, will result in lower and lower rates when it is time to renew the CD.
Don’t believe me?
Go to your local bank and see which rates are higher, short or long term. You’ll see that CD specials are for short terms, and that typically short-term rates are higher than long-term rates. The reason for this is that rates are dropping.
How long can the rates possibly drop though, right?
Remember what CD’s were paying in 2003? According to the Federal Reserve the average 6-month CD was paying 1.18%. The years immediately before and after, 2002 and 2004 were not much better, both under 2%.
If rates continue to drop all year like analysts indicate seeing those low rates again is a very real possibility.
If you invest in CD’s to watch your money grow this can present a significant setback. If you invest in CD’s and take the interest as income this could be devastating.
If you are using CD’s for income, particularly if you live on a fixed income and CD’s provide vital income to sustain your livelihood, you will see your income drop. Any other fixed investment is going to be suffering the same drop.
So, what is the solution?
Ideally, the best rate for the longest term will be the way to go here. Ride out the downturn until rates begin to significantly recover. Analysts are saying that this can take about three years.
It may be time to start looking at bonds and annuities. Depending on the annuity product and company you may have many options to grow your money with various terms.
If it is income that you need annuities are made to provide guaranteed lifetime income. This typically represents an interest payment accompanied by a partial return of your principal.
What that means is that the amount of income you receive could be significantly higher than what a CD would pay, part of your income payment may be tax deductible, and you will receive this income for the rest of your life, no matter how long you live.
The drawback is that if you decide to stop the income you will likely not receive your entire principal payment in return. Also, in the event of your death your heirs may not receive anything from the annuity, even if your principal has not been entirely depleted.
Many annuities offer ways to distribute a death benefit to your beneficiaries however, and typically the amount of income you will receive on a regular basis will be discounted for this benefit.
Carefully consider your options as interest rates continue to fall. There is no one answer for every person. Before you decide to do anything get all the information and understand what you are purchasing.