Point of n% return?

The booming stock market has trampled the comfortable certificate of deposit, leaving a murky future for an investment whose rates continue to rise.

By SCOTT BARANCIK

© St. Petersburg Times, published May 7, 2000

After years of pitiful returns, interest rates on certificates of deposit have crept back up to a 5-year high. Banks are trumpeting their return in newspaper ads and branch windows.

That's great for retirees who depend on ultra-safe interest income, but other investors could hardly care less. "I made 40 percent last year on my investments," said Hudson resident Barbara Perkins, a 54-year-old occupational therapist who began investing seriously for retirement two years ago with the help of an adviser. "Why would I bother with a 7 percent CD?"

The bravado among everyday investors appears unshaken by the market's recent volatility. The Dow Jones Industrial Average has climbed or plummeted at least 2 percent on 18 days this year. A spooked investor could easily be forgiven for liquidating her stocks and buying a nice, comfy CD.

Banks, especially, would love that to happen. "High return. Zero risk," reads a CD advertisement placed by World Savings Bank.

San Francisco-based Providian Financial Corp. is dangling a $50 cash bonus in front of Internet customers willing to pump $5,000 into a 1-year CD with a 7.14 percent yield.

Not every bank and thrift is offering such come-ons, but average CD rates have risen steadily over the past 16 months.

According to bankrate.com, the average yield on a 1-year CD in the Tampa Bay area reached 5.25 percent last month, or about one-third more than in early 1999. Some area lenders, such as Hamilton Bank and Southern Exchange Bank, are bidding nearly 7 percent for your dollars, though the required minimums can be hefty.

That's a far cry from the double-digit CD rates of the early 1980s. But with inflation expected to reach just 2.5 percent this year, the "real" return on today's CDs -- yield minus inflation -- isn't bad, especially when you consider they're insured by the federal government.

"Unless the Russians take over, you've got a $100,000 absolute guarantee on your money," said Michael J. Turrisi, president of Financial Advisory Services of Tampa.

Much has changed since the early 1980s, however. Mutual funds were introduced, offering unsophisticated investors an easy and relatively safe way to dip their toes into the stock market. The invention of the Web browser paved the way for online brokerages to offer stock research, real-time prices and discounted trades to average Americans. And the U.S. economy embarked on an unprecedented growth spurt that continues to this day.

Meanwhile, the stock market went berserk, creating fortunes both large and small. Many investors have since come to view double-digit annual returns as an entitlement.

Together, these developments have made the CD about as popular as a rice cake at a Krispy Kreme doughnut shop.

"My clients don't invest in CDs," Turrisi said. "Long-term investors understand the slings and arrows of a volatile market."

Government statistics prove the point. In 1998, the latest year for which data are available, CDs accounted for just 4 percent of the average family's financial assets, far less than stocks (23 percent), mutual funds (13 percent) and retirement accounts (28 percent). In 1999, Florida depositors pulled more money out of CDs worth $100,000 or less than they put in.

At the same time, demand for stocks and mutual funds has grown. At Charles Schwab & Co., for instance, brokerage customers poured a record $9.9-billion into mutual funds in the first quarter of this year, compared with $10.3-billion in all of 1999.

"We've had absolutely zero requests from people saying, "Look, I really want to liquidate and get safe in cash,' " said Group One Associates consultant Richard T. Butt, whose clients include Barbara and Gary Perkins.

While investors were transfixed by the stock market tickers on CNBC, a number of forces have converged to shove CD rates upward.

One is the growing need for credit, which is characteristic of a strong economy. Between Jan. 1, 1993, and Jan. 1, 2000, the volume of loans held by U.S. banks and thrifts grew 59 percent. To bring in money to fund the loans, banks have had to lift CD rates.

"They need deposits, and they're willing to pay for them," said Bert Ely, a bank consultant in Alexandria, Va.

Technology has lifted CD rates, too. Thanks to the World Wide Web, an Idaho bank doesn't need to open a branch here to reach bay area residents; it can advertise its rates online. Branchless banks that exist only in cyberspace have sprung up, too, and because of their low overhead, they can offer better rates. The result has been tougher competition for deposits and higher yields all around.

Alan Greenspan has also played a key role. To curb inflation, the Federal Reserve chief and his colleagues have raised short-term interest rates five times since June and is poised to raise them again next week. The move has caused bankers to raise interest rates on both loans and savings accounts, including CDs.

But will CD rates continue to rise?

In the short-term, the answer depends largely on future moves by Greenspan and the Fed. And the long-term forecast for CDs is cloudy.

As far as banks are concerned, CDs are becoming almost passe, providing less than one-quarter of the money they use to fund loans. One reason is industry consolidation: 2,882 banks disappeared from 1993 to 2000, mostly because of mergers and acquisitions. Those that remain are twice as big on average and can easily obtain funds by issuing securities or floating bonds.

Smaller banks increasingly are turning to the Federal Home Loan Bank system, which lent them nearly $400-billion in 1999, up one-third from 1998.

The broader question is whether anything will lure today's investors into CDs.

"You have to realize who's investing now," said Lisa Langan, a regional manager for Miami's Hamilton Bank. "It's the younger people, who are used to this risk."

Of course, it's easy to back a winner.

When Michael Jordan was dominating the NBA, Chicago Bulls fans could tolerate a loss here or there because they knew the basketball team would win it all in the end. Home games were sold out for years. Now, with Jordan retired and the Bulls in last place, many former fans are finding better ways to spend their time and money.

Some financial advisers say the same thing could happen to Wall Street.

"If we had a sustained bear market, would people be fleeing their investments? Yes, because a lot of people haven't experienced a long-term downturn," Turrisi said. "I mean, you have to go back to Vietnam and Nixon."

-- Times researcher Caryn Baird contributed to this article.

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