New Bank Fees Wipe Out Paltry Cash Account Interest Income

If you were offered an investment opportunity that had a decades-long history of paltry returns or, much of the time, actually losing money how excited would you be to dive in?

I've never been a fan of investing in bank certificates of deposit (CDs) or money market accounts and now there is a new reason for fixed-income investors to look elsewhere.

By the time you pay the taxes on the interest that you've earned and subtract inflation from your principal, CD and money market investors are freqently losing money.

Here's a quick example using today's 1.9% average interest rate on a 12-month bank CD and the current (ending November 2009) 1.84% annual inflation rate. If you invest $1,000 in a 12-month bank CD you will earn $19 in interest income. That interest is taxable at, say, 40% (federal plus state), so you lose $7.60 to taxes. You are now down to $11.40 in net interest earnings after one year when the bank gives you your $1,000 back. But your original $1,000 is now only worth $981.60 (you lose $18.40 to inflation). So even though you made a net $11.40 in interest income, you actually lose $7.00 for every thousand dollars invested in that CD ($11.40 minus $18.40 for inflation).

And any money you have in a money market account is even worse off since those accounts are currently paying less than 1%.

But here is a new twist that makes such investments even worse. Many banks have started charging a monthly or quarterly fee for such accounts. The fees aren't a lot, but today's low interest rates on CDs and money market accounts have now dipped below those fees. What that means is that for many investors your bank's account fees are now wiping out any interest gains entirely, before you even get to taxes and inflation.

Bill Gross, CEO of Pimco and one of the world's most successful investors, tells of his dismay when he reviewed his own personal account statement recently to learn that at the current .01% his money market account is paying it will take 6,932 years for his savings to double (click to see article).

The highest quality preferred stocks provide an alternative worth considering, especially in this low interest rate environment. I am specifically referring to preferred stocks that (a) are issued by a company that has never missed a preferred stock dividend payment, (b) are 'cumulative' so that if a dividend payment is deferred the issuing company still owes you the money and (c) carry an investment grade rating. Such preferred stocks are currently providing an average annual dividend yield of 8.1%.

My book, Preferred Stock Investing, describes how to screen, buy and sell the highest quality preferred stocks. If you would rather someone else do the research and calcualtions, I offer the CDx3 Notification Service, an email service that makes you aware of buying and selling opportunities for the highest quality preferred stock issues (read more).

Cash account fees, taxes and inflation are not only completely wiping out interest earnings, but also eroding the principal that fixed-income investors are putting into such accounts. The highest quality preferred stocks may offer respectable returns at acceptable risk to many individual investors.

Many Happy Returns.