Which Account Would You Choose?

Thanks to my colleague, Jessica, for letting me know about this phenomenon of a 10 year CD with an interest rate below a regular savings account.  So, the question for your students is this:

Suppose you had $500 that you didn’t think you would need for a long time.  Would you invest in a 10-year CD earning 0.90% or a regular savings account earning 0.75% interest?

Some good points for a discussion:

  • Locking into a 10-year CD hurts your option value to invest in a CD with a higher interest rate which may appear as interest rates rise.
  • Federal Reserve has announced that they will be raising interest rates sometime in 2015 for first time in over six years.
  • You would only make the decision to invest in the CD if you believed that interest rates were going to fall so there was an advantage to locking in a higher interest rate NOW.  Looking at this historical chart of T-bill rates (a proxy for interest rates on savings accounts) suggests that interest rates have no place to go but up.
  • “Bricks and mortar” banks traditionally offer lower interest rates than online banks.  Why?  A very different cost structure.