Much lament is heard these days about the low interest rates available to CD holders. For those whose budgeting includes interest from CD’s to pay for groceries, it must be truly depressing. Hopefully this concern will lead to the investigation of safe alternatives. A willingness to consider insurance contracts with sound companies can result in yields of 7% or more on a contractually guaranteed basis, without exposing your principal to loss from market forces.
Albert Einstein said that compound interest is “the greatest mathematical discovery of all time.” It follows from logic that time is the best ally of a prudent investor. For those who have time to allow money to work, it is important to understand the different impact of various rates of interest that are available for those who wish to enjoy to avoidance of loss of principal.
Financial planners make reference to something called a ‘rule of 72′. This is a simple rule of thumb that helps you to understand how long it takes for money to double in value. It works like this: Divide the interest rate you receive into 72. The result gives you the number of years it takes for your account value to double.
For example, at 3% interest, it takes 24 years for the account to double. At a 6% rate of interest, it takes 12 years, at 9%, it takes 8 years and so forth.
Let us assume that you have a $50,000 account at the bank earning 4% interest, and you wish to use that account in 10 years to supplement your income.
Here is what that account will be worth in 10 years at four different interest rates:
4% – $74,012
6% – $89,542
8% – $107,946
These returns do not reflect the erosion that results from income taxation. Now assuming that all accounts are principal guaranteed, which would you like to have working for you?
With current interest rates offered in the marketplace hovering around the 2% mark, it is not too difficult to understand why most banks have an annuity desk in their lobby to show people how they can take advantage of the benefits of putting some of their safe money into insurance company investments. They will fully explain how these companies are able to offer higher interest rates, and how their safety features work. After all, it is reasonable to ask how much risk is involved to move from a 2% account to a 6% account, and also what other terms and conditions apply that you need to know in advance.
This leads to a discussion of the individual merits of the insurance company proposed, and at a time when all financial intermediaries are being scrutinized, you must be prepared to compare their finances with those of the bank itself. Since annuities are not subject to FDIC insurance, you will need to know more about the guaranty plans in the state in which you live. This can be readily obtained.
We have made reference to the ‘Rule of 72′, but only in connection with the mathematical difference in accumulation values for an account. It also works in connection with the impact of inflation, and it explains why it is significant to understand why it is important to seek the highest safe interest rate available.
To give a brief example, a 4% inflation rate means that you purchasing power is cut in half in 18 years. If you are doing long term planning for your investments, you will need to achieve an interest rate greater than inflation if your goal is simply to maintain purchasing power.
You can, of course, take the easy path in your decision making process. Simply choose to rely on someone you trust to assist you with the selection of the best company. In this respect, you are truly blessed if you have access to such an adviser. This is very similar to your good fortune in finding a competent and conscientious auto mechanic, or a medical adviser. You have a very valuable asset in knowing such a person. Send them an appreciation card – today!
