Monday Morning: Investors putting far too much into CDs

Americans still put the largest share of their savings ($466 billion in 2002) into housing, according to the Federal Reserve’s “Flow of Funds Report.”

However, other than residential real estate, the largest amount of personal savings in the past three years went into time and savings deposits, according to the report.

In 2002, individuals socked away $279.2 billion in such accounts, up from $256.9 billion the year before. By comparison, they put $180.4 billion into corporate bonds, $128.2 billion into mutual fund shares, $108.8 billion into municipal bonds and $58.8 billion into cash or checking accounts.

Americans took $228 billion out of government bonds, $76.2 billion out of corporate equities and $39 billion out of money market funds.

Since a large portion of those time and savings deposits is in certificates of deposit, it is obvious many investors aren’t getting the message that it isn’t generally a good idea to leave significant amounts of money in CDs.

Fixed-rate five-year jumbo CDs offer yields of about 4.21%. Most financial planners can suggest better ways to invest the money.

Unfortunately, many individuals may not even mention their CD investments to a financial adviser. In part, that may be because they bought these CDs at their local bank while taking care of day-to-day banking transactions.

In addition, many individuals like the safety of federally insured CDs and the fact that the money is in a bank, the epitome of safety in their minds.

Besides the potential for higher return elsewhere, one key problem with CDs is that until recently, they weren’t protected against inflation. Even though inflation is low at about 2.3% a year, according to the most recent report from the U.S. Department of Labor’s Bureau of Labor Statistics, it can still harm the purchasing power of an investment return.

In fact, a 4.2% yield from a CD would lose more than 11% of its purchasing power over the five-year holding period. A 10-year CD would lose more than 20% of its purchasing power over 10 years.

Those are tough losses for people on fixed incomes.

Investors could always buy Treasury inflation-protected securities, which pay a yield continuously adjusted for inflation, but they are auctioned only four times a year and only in 10-year maturities.

An investor who wants to buy at other times or for different maturities has to buy on the secondary market, paying a premium.

In addition, TIPS must be purchased from the Treasury either directly or through a banking institution. (I know from personal experience that some bank personnel are ignorant of TIPS and need to be brought up to speed when you place your order.)

LaSalle Broker Dealer Services Division in Boca Raton, Fla., claims to have solved these problems for inflation-conscious, conservative investors. It has introduced inflation-protected certificates of deposit, or CDIPs.

The LaSalle unit comprises divisions from Chicago’s LaSalle Bank NA and its non-bank subsidiary, ABN AMRO Financial Services Inc.

According to Patrick J. Kelly, senior vice president at the broker-dealer-services division, CDIPs “do exactly what TIPS do but are available 365 days a year at par.”

They can be purchased from almost any broker, Mr. Kelly says, making them easier to acquire than TIPS, and they are guaranteed by the Federal Deposit Insurance Corp. up to $100,000.

Of course, the broker earns a commission for selling CDIPs, but it comes out before the rate is set, so investors get the rate they expect.

Last week, 10-year CDIPs were paying an annual yield of 2.4% plus inflation, or about 4.7% given current inflation rates. Five-year CDIPs were paying 1.4% plus inflation.

Funds in CDIPs can’t be withdrawn early, but the CDIPs can be sold on the secondary market or can be redeemed at the inflation-adjusted amount upon the death of an owner or co-owner.

CDIPs may be a better idea for clients concerned about the security of investments and inflation than the regular CDs they have been buying. If you can’t persuade them not to keep too much money in CDs, CDIPs may be a good alternative.

Mike Clowes is the editorial director of InvestmentNews and sister publication Pensions & Investments.