With certificates of deposits paying only around 1% interest, many income investors are looking for alternatives to CDs.
Exact interest rates will change in the future, but right now certificate of deposit interest rates run from under 1% for six months to over 2% for five years.
People Want Higher Incomes from Their Money
These low rates are driving many people who need income from their investments to take their money out of CDs and put it into the stock market, in hopes of making more money.
Depending on your needs, this could be a good idea -- or a terrible one.
When you take out a certificate of deposit, the bank or other financial institution uses your money to make short-term commercial loans to businesses needing immediate financing. Because the businesses pay them back quickly, they pay a lower interest rate than if they were borrowing the money for a long time. That's another reason the bank pays you a low interest -- the shorter the term of the savings certificate, the lower.
CDs and Money Markets are Safe
However, the main point is that your money is safe. Of course, occasionally businesses default on their loans. But banks allow for that when they set the interest rates they charge -- and pay. It's an expense of doing business.
Also, if your CD is with a bank, it's insured by the government through the Federal Deposit Insurance Corporation (FDIC). That's not a perfect system -- and the FDIC's funds have been drained the past few years by the financial crisis and a wave of failed banks -- but it's about as much protection as we get in this imperfect world.
I believe money market funds are a better deal. They also pay low interest rates, but you have more access to your money. You can write checks on the funds without caring about a maturity date.
General money market accounts are not insured by the government, but you can open up money markets that invest only in Treasury bills, which are guaranteed by the government.
But it's true that if you want a higher investment income, money market funds are not what you're looking for.
When Do You Need This Money?
Is this money parked for the short term, such as for a vacation, house downpayment, college tuition or other purpose to be spent within five years? If so, leave it there. The stock market is too risky. It's gone nowhere in the past eleven years. You have no guarantee it will go up in the next five. It might go down again.
The Stock Market is Not Safe
Plenty of stock investors wish they'd kept their money in certificates of deposit instead of the market.
However, if you need investment income because you're retired, or you're saving up for retirement, then you should get that money out of both certificates of deposit and money market funds (though do keep some emergency funds in a money market account).
Average stock dividend yields are not much higher than CD interest rates, it's true. The S&P 500 as a whole currently yields about 1.6%. If you bought only the dividend paying companies in the S&P 500, you'd get a yield of around 2.5%.
However, the good thing is your dividend income will grow over time. That's your best bet against inflation robbing you of your purchasing power.
Some Types of Stocks Pay Higher Dividends Than Others
Yet you can do even better. You can invest in corporations that pay dividends higher than the S&P 500 average. You can invest in companies that are not corporations, but business structures which do not pay taxes so long as they pay out 90% to their owners.
Savvy income investors put their money into a diversified portfolio of these high-yielding investments and collect growing dividend checks for the remainder of their lives.
Author Resource:
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