Why You Shouldn’t Invest in T-bills and Certificates of Deposit (CDs)

I was working on my income tax return last spring when I noticed something new: the banks in which I had stuffed my pitiful savings were not bothering to send me forms indicating how much interest I had earned. It was so little it was not worth reporting!  Look at any savings account and you’ll see you are getting 0.02% annual interest (or something like that). Even CDs and most T-bills are around 1%. What’s a thoughtful, savings-minded person to do? You can go into the stock market and see higher returns, but you can also lose your shirt, which will make retirement chilly.

For homeowners and coop and condo boards, as well as solvent building owners, there is a reasonably secure alternative, and (of course) it’s energy efficiency, which amounts to a CD returning real interest, just like the old days, of 3% to 10% or more.

To see how this works, think about a CD.  You invest some amount of capital, say $1000, at some specified interest rate, for some fixed period of time, normally a few years. You can’t touch the money during that time without penalties, but at the end you get back your capital plus the earned interest. The only problem is that these days the earned interest isn’t worth your time going to the bank.

With energy efficiency, the structure’s a little different, but the result is much better. You invest some amount of capital, say $1000, in better lighting that will use less electricity. Because it uses less electricity, you save money on your electric bill every year. If your bill is $200 less than it would have been without the improvement, we say there was a simple payback period of $1000/$200 or five years.   So after five years you have gotten your investment back. But the new lights are still working and still saving $200 per year (or more if the electric rates go up). Suppose the lights will last for ten years – you will pick up another $1000 in the second five years of their life, for a total of $2000 in savings on a $1000 investment.  Ask your banker (or check the equations below) and you’ll see you got a 10% return on your investment over the ten years.  It’s not taxable, and you can’t get a return like that anywhere without selling your immortal soul.

Here’s the general formula: suppose you have an energy efficiency investment that pays for itself in P years. (P= payback period.) And suppose the installed system has a life expectancy of at least L years. (L = minimum system life.) Then the equivalent after tax interest is I = 1/P – 1/L.  This includes the obvious requirement that you get your capital back, just like with a CD.

Got CFLs? Payback P = 1 year, often. Lifetime L = 3 years. The interest rate on these 3-year CD equivalents is 67%!!  (I = 1/1 – 1/3 = 0.67.)

Of course, to actually end up with money, the way you do with a CD, you must have the fortitude to stick the savings into a bank and let them add up over the “L” years of the technology you have chosen. Even better, take the savings and invest them in some other energy efficiency improvement, and you will be compounding your interest in a way CDs can’t possibly duplicate. But I digress.

Again, maybe the nicest feature is that there is no 1099-INT, despite the serious levels of interest being earned!

The math:

K = capital cost ($)

A = Annual savings ($/year)

P = Payback period (years) = K/A

L = System lifetime (years)

Total income = L x A = L x K/P

Net income after capital = L x K/P – K

Net income after capital per year = (L x K /P – K)/L = K/P – K/L

Interest = net income after capital per year as fraction of capital

Interest = (K/P – K/L)/K = 1/P – 1/L