CD Rates Near All-Time High! No, Really

(MoneyWatch)  For those who think the idea noted above is as mad as a bag of ferrets, and that I probably am as well, consider the following.

First of all, I realize that the highest paying one year CD as of today is at Melrose Credit Union in Briarwood, N.Y., and is only paying 3.03 percent APY. I also realize that just a year ago one could find a CD paying over four percent, and that in 1979 or so that rates were somewhere around 15 percent. Yet I'm arguing that for the rational investor, there's never been a better time to buy a CD.

Let's go back to 1979, shall we? Say I stash $1,000 in a 15 percent CD and compare it to the 3.03 percent CD I can get now. We'll assume a 30 percent combined federal and state tax bracket.

	1979: 15% CD	2009: 3.03% CD
Original Principal	$1,000	$1,000
Interest	$150	$30.30
Taxes (30%)	($45)	($9.09)
Total	$1,105	$1,021.21

Clearly the 15 percent CD of my youth paid much more, but let's look at what was going on with inflation back then. According to the Bureau of Labor Statistics, inflation was then at 13.3 percent, while it's currently roughly zero. Now let's get real about our earnings and see what happened to our spending power:

	1979: 15% CD	2009: 2.8% CD
CPI	13.3%	0
Real inflation-adjusted dollars	$975.29	$1,021.21
Change in spending power	(2.5%)	2.1%

The bottom line is that is that the CD today increased my spending power by just over two percent after taxes, compared to the 1979 version which decreased it by 2.5 percent. Thus, today's CD gives us a real after-tax advantage of 4.6 percent!

That's the good news. The bad news is that, for whatever reason, investors are happier with a higher nominal return even though our purchasing power is shrinking. That is to say, we would rather earn 11 percent with 13 percent inflation than earn two percent with no inflation. This is completely irrational, but it's also human nature.

My advice
It's not easy, but it's important to get real when it comes to investing. Keep in mind that CDs backed by the U.S. government are the one advantage small investors have over the big guys. If an institutional investor wants to invest a billion dollars in risk-free instruments, they can buy a one year Treasury bill yielding 0.54 percent as of the time of this writing. The $250,000 (changing back to $100,000 at the end of the year) FDIC and NCUA insurance is of little value to the institution. Small investors, however, can stay below these limits and earn nearly six times this rate.

So if you can approach this rationally, CDs are great investments right now. And always make sure your CDs are backed by the U.S. government, as this is the only entity licensed to print money. It takes a little more work to find these CDs, but the extra return is like getting free money.