Even CD's have a risk

As the financial world looks back on the past year of horror known as the collapse of the financial system, investors still look for ways to make money in the markets. Some have sworn off stocks and mutual funds forever, stating the risk of loss is too great and the possible recovery could take too long. Others have given up on bonds due to the risk of default which seems much higher today than in previous times. Side note: high yield or "junk" bonds have been the best asset class to own in the past year! Real estate investors have seen their portfolios deflate and harder to sell as the financial crisis became a credit crisis for potential buyers. Even gold, while inching towards the $1000 level again is still off 50% or better when looking at it on an inflation adjusted basis. The result? Many scared investors have turned to CD's offered by banks. They don't have any risk right? After all, you cant lose your money in a CD can you? Well, they are principal protected, but to say they don't carry a risk would be untrue. The risk with CD's is interest rate risk. When you buy a CD, you lock in an interest rate for the term of the CD. While this may be good when rates are falling, it's bad when rates are rising. The risk with a CD is, you do not know what the interest rates will be when your CD matures. So if you bought a CD that was paying 5% when you bought it, you might only get 2% when it comes time to reinvest that money. For people who live off the interest earned on CD's, this can be very bad. Some people have been speculating that interest rates are due to rise because inflation is imminent with all the government spending and bailouts this past year. Most economists dispute this theory, at least in the short term, and don't expect interest rates to jump until late next year or even 2011 at the earliest. So those CD buyers who purchased 6, 9, or 12 month CD's expecting higher rates next year, could be in for a rude surprise. So what's a CD shopper to do? Come back next time and we'll discuss a few strategies...