How can you tell if what you are being offered is a high return? Here are some tools you can use. CDs or Certificates of Deposit from FDIC insured banks generally offer you Fed Funds minus a little. Fed Funds right now are at 4.0%.
TDs or Time Deposits are like CDs, only on amounts over $100,000. The amounts over $100,000 are not insured by the FDIC. So, TDs generally have to offer a higher return to make up for the loss of the guarantee. They generally price at LIBOR flat or LIBOR minus a few basis points. LIBOR is the London Interbank Offering Rate or the rate that banks sell money to each other. One month LIBOR right now is 4.166%.
Because corporate bonds face the risk that the company will go bankrupt, they pay a higher rate than Treasury notes. The spread is from zero to 5 basis points for a AAA bond and from 25 to 100 basis points for a BBB bond. A basis point is 1/100 of a percentage point. So, in the Fed Funds example above, the .75% of the 3.75% represents 75 basis points.
Equities or stocks offer returns of between 10% and 12% annually for a broadly diversified portfolio.
Also, the risk increases as you move from CDs to stocks. Stocks offer a higher average return, but they also offer the risk of a larger loss.
Tomorrow I’ll talk about diversification.
Nicely said. I look forward to more wisdom. My funds could use some growth!
Posted by: Hal Halladay | November 22, 2005 11:24 AM | Permalink to Comment