With interest rates still close to all-time lows, conservative investors are realizing that traditional forms of low-risk investments are not keeping up with inflation. According to Bankrate.com, the interest rate on average for a five-year bank CD is 2.13%, and the average bank money market is 0.12% APY.
Considering inflation is historically 3%, that discrepancy between return on investment and rising prices can be detrimental to a retirement plan. Look at it this way: If your investments are returning 1% per year, and inflation is 3% per year, you actually lost 2% in value on your money in one year. That might not seem like a big deal, but when you look at the increasing life expectancy in the United States, it becomes an issue. Currently the average life expectancy is around 85 years old. Assuming that life expectancy does not increase over your lifetime, a 60-year-old retiree could be retired for 25-40 years.
Let’s do some simple math:
1% interest – 3% inflation = -2% purchasing power
-2% purchasing power x 25 years = -50% purchasing power
-2% purchasing power x 40 years = -80% purchasing power
Why People Invest in CDs or Money Markets
From my experience, people who invest in CDs, money markets and other lowing paying interest rates do so for one of three reasons:
- It’s how they’ve always invested, so they just continue with what they’re comfortable with
- They’re worried that all other investments will involve risk
- They don’t know all of their options
If you’re in the first category, you might want to consider staying in those types of investments. Sometimes a better return on investment isn’t as important as being comfortable with your investments. If you fall into the second two, here are some investment options that are fixed, will typically keep up with inflation, don’t have any investment risk and are offered by insurance companies instead of banks.
Multi-Year Guaranteed Annuity
How does a multi-year guaranteed annuity (MYGA) work? This is the closest investment to a CD. They give you a fixed interest rate for a set period of time and it will not change over that time frame.
For those guarantees, the insurance company will ask you to leave your money there for a specific time period, just like CDs. The differences between CDs and MYGAs are typically the insurance company will allow you to take out up to 10% from your MYGA without losing any of your interest, and the interest grows and compounds tax-deferred.
Who should use it? Someone who doesn’t want any surprises. If you want to know exactly how much interest you will make over a certain time frame, regardless of market performance or future interest rates.
Fixed Indexed Annuities
The interest rate on a fixed indexed annuity (FIA) is based on a designated market index. There are many different market indexes you can chose from including S&P 500, gold, real estate, foreign markets and many more. What makes these accounts fixed is that they have a minimum guaranteed interest rate, or floor, where if the market index decreases in value, your account will not decrease in value with it.
In return for that safety, the issuing insurance company will typically ask for a time commitment of five years or more and they will cap how much you can make or will only give you a percentage of the market index returns.
Who should use it? This investment is good for anyone who doesn’t mind fluctuation in their annual interest rate, but doesn’t want any negatives in their investments. Also, people who need growth and safety—FIAs traditionally return some of the highest returns out of any fixed investments. (For related reading, see: Are Equity-Indexed Annuities for You?)
Return of Premium Life Insurance
There are many different types of life insurance, and some of the newer policies have a "return of premium" provision that states if you ever cancel the contract you get your money back. These newer policies offer other features as well, from enhanced (tax-free) death benefits to long-term care riders.
Who should use it? Anyone who is healthy and doesn’t plan on using that money for normal expenses. If you’re only planning on leaving the money to beneficiaries or using it for long-term care, the insurance company will give you back more (based on age and health) on your investment for those specific things. And if you’d like to cancel the contract they just give you your principal back.
These investments definitely aren’t for everyone. This article is meant to introduce you to different kinds of alternative low-risk investments and help you understand whether or not one of these alternative options is a good fit for you.
(For related reading, see: Alternatives to Low-Yielding Bonds.)
Securities and advisory services are offered through Madison Avenue Securities, LLC (“MAS”). Member FINRA/SIPC and a Registered Investment Advisor. Anders & Anders Financial Group and Madison Avenue Securities, LLC are not affiliated entities.