By Dr. Gary L. Deel
Faculty Director, Wallace E. Boston School of Business
and Dr. Karin Ford-Torres
Faculty Member, Wallace E. Boston School of Business
This is the third article in an ongoing series on sound tips for financial security and prosperity. Nothing in these articles is intended as formal legal or financial advice. Readers should consult with an attorney or licensed financial advisor before making any financial decisions.
In this installment of the Smart Personal Finance 101 series, we’re covering interest earned on money invested. Interest earned on investments works essentially the same way that interests owed on loans does.
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The big difference is that this interest is coming in and not going out. Interest on investments is often described broadly as “return on investment” (ROI), but it is usually quantified as a percentage and as such can be thought of as interest.
Interest Rates for Different Investments Commonly Vary
Interest rates for different investments vary quite a bit. When we’re talking about investment interest, we almost always think and speak in terms of annual returns.
For example, checking and savings accounts sometimes offer very modest returns of maybe a fraction of a percent per year. Certificates of deposit (CDs) can earn a bit more usually in the 2% per year range, depending on the amount of money deposited and the amount of time it’s held.
These interest rates are fairly low, but the advantage to these options is security. These types of bank-held funds are insured up to $250,000 by the Federal Deposit Insurance Corporation (FDIC), so investors are guaranteed to keep their initial investment and earn the interest promised at the onset.
Unsecured Investments Can Outperform More Secure Options
There are many other types of unsecured investments that regularly outperform secured options — and not just by a little bit. For example, many index funds for securities traded on the stock market routinely earn 7% or more per year. And stock market investment is entirely passive.
Also, there are other investment options such as rental properties. Although these investments generally require more direct involvement and oversight from the investor, they typically yield a higher rate of annual return, which can be 10% or more depending on the type of property and the market.
But unlike bank-held investments, these other types of money-making opportunities are not protected or FDIC-insured. So although profit may be likely, it is never guaranteed.
Furthermore, economic downturns and crises could actually mean that investors lose money at the end of the day. This is the risk inherent in pursuing higher-yield options.
Why is it important to understand both interest paid on debt and interest earned on investment? In the next article, we’ll look at how relative interest analysis and careful scrutiny of options is critical to successful financial management.
The university offers academic programs in accounting and finance, which cover important financial discussions in depth. Readers who are considering expanding their knowledge and credentials in this field are encouraged to visit our program pages for more information.
About the Authors
Dr. Gary Deel is a Faculty Director with the Wallace E. Boston School of Business at American Public University. He holds a J.D. in Law and a Ph.D. in Hospitality/Business Management. Gary teaches human resources and employment law classes for American Public University, the University of Central Florida, Colorado State University and others.
Dr. Karin Ford-Torres is an Associate Professor with the Wallace E. Boston School of Business at American Public University. She holds a Ph.D. in Business Administration with a concentration in Advanced Accounting and Financial Management. Karin teaches accounting and finance courses for American Public University, Purdue University Global and Colorado State University-Global. She has 24 years of prior banking experience with Bank of America.
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