HIGHER INTEREST DOESN’T ALWAYS MEAN A BETTER INVESTMENT

I’m a lawyer. I don’t give investment advice. Giving investment advice seems to me to be something like predicting the weather – we can all take a stab at it, few will be correct.

Since most of my clients are senior citizens, I don’t think I’m revealing any confidences by saying that their investment of choice is a certificate of deposit (CD). When I ask a client how they have their money invested, they might tell me that they have six CDs worth a total of one hundred thousand dollars, with varying maturity dates stretching out over several years.

As you may know, the longer you agree to “lock up” your money in a CD – that is, the further out the maturity date – the higher the interest rate the bank will give you. For example, a bank may give a 1.5% rate for a 6 month CD, 2% for a 2 year CD.

My clients like CDs because they offer security. They know their money will always be there and that they’ll earn a specified rate of return, guaranteed. Now, an investment advisor might tell you that a 1.5% annual rate of return is actually losing money if inflation is occurring at a rate of 2.5% annually. Since the price of goods are increasing an average of 1% more than your money, your money is actually worth less than before you invested it.

I think my clients understand this, but they still like the safety and security that comes with a CD. And, what they do to combat inflation in a low interest rate environment is extend the terms of their CDs; for example, perhaps a 4 year CD yields a 2.75% rate of return.

Another “guaranteed” investment vehicle is an annuity. An annuity is a contract through which a company – often an insurance company – offers to pay back the principal that you invested with them plus interest over a given term of years or for life. For example, I invest $100,000 with an insurance company, and the insurance company offers to pay me back my $100,000 plus 5% interest for the next 10 years.

Both annuities and CDs offer people the security of knowing that they will receive a given interest rate, over a given period of time, and that their money will be there. Both annuities and CDs can, however, cause problems.

One problem that I see with these investments is the “penalties” that clients will pay if they redeem the CD or annuity before its term. For example, an annuity contract might say that if the contract is cancelled before its term, the annuitant (the person buying the annuity) will pay a 7% penalty. A CD might say that if the CD is redeemed before its maturity date, the account owner will pay 3 months interest as a penalty.

So now I have a client sitting in front of me. She’s worried that her husband will never come out of the nursing home and that they’ll have to spend all of their money on his care. She’d like to engage my firm to help her with “Medicaid planning,” a process through which people can shelter assets and qualify for Medicaid benefits more quickly than they would if they failed to plan.

But what about the penalties? They have $200,000 in liquid assets – that is, assets other than the house – and most of those assets are invested in CDs and an annuity that they purchased two years ago and has a 15 year term.

This presents somewhat of a problem because the CDs and the annuity may very well need to be redeemed. While this problem is not insurmountable and the wife can plan for the husband’s Medicaid eligibility, some of their money will be forfeited to the bank and the insurance company in the form of a “penalty.”

So, while I don’t give investment advice, I do warn people about the dangers of tying up their money for extended periods of time, particularly when they are in an age group that has a high probability for requiring long term care. Shorter investment cycles, with slightly lower interest yields, may actually save money in the long run and offer greater peace of mind.