People who use certificates of deposit (CDs) to store their money safely tend to do so to avoid the risk associated with market-based assets, such as stock and bonds. However, for long-term investors, CDs may present a different type of risk that can be just as harmful as market risk—the risk of inflation. If the return on an investment does not at least keep up with the rate of inflation, it will result in the loss of purchasing power over the long term.
Currently, rates on CDs barely exceed the Consumer Price Index (CPI) rate. CD rates tend to track the CPI, which should alleviate concerns over inflation risk. However, a closer examination of how inflation is measured may be a cause for concern if you’re worried about your actual purchasing power in the future.
CDs vs. CPI
As of April 2022, the best one-year CD rates on the market were 2.25%, and the average was 0.17%. The average five-year jumbo CD rate was 2.35%. This means that at the moment, with inflation running at record highs, the rate of inflation is far higher than the return paid on CDs. This is true when one compares the average CD return to the standard CPI rate, and even more so when compared to the Core CPI rate, which may be a better measure of inflation in this context.
CDs vs. Core CPI
The primary difference between the CPI and the Core CPI is that the CPI doesn’t include oil and food prices. With oil and food prices factored in, the Core CPI stood at 8.3% in April 2022, much higher than the CPI rate. The CPI is the number that the government likes to report, but the Core CPI is the number that most economists tend to follow. If you apply the Core CPI to the CD-vs.-inflation equation, CDs are behind by a large margin.
CDs vs. Lifestyle Inflation
The inflation rate that should matter most to consumers and CD investors is what they actually feel in their wallets. Even if oil and food prices were included in the CPI, you may not feel the same effects of inflation as your neighbor if you don’t drive often or don’t eat a lot of corn. Lifestyle inflation, which is driven largely by consumption habits, has the most direct impact on purchasing power. Since most people consume gas and food, it would be very difficult to keep your lifestyle inflation rate much below the Core CPI rate. For many people, it can be much higher.
CDs and Taxes
By some measures, CDs may be able to keep up with inflation. However, your actual purchasing power is based on your income after taxes. The interest earned from CDs held outside of a qualified retirement plan is taxable as ordinary income, so the net return of CDs is reduced by your effective tax rate. If your effective tax rate is 25%, the net return of a CD yielding 1% is only 0.75%.
What is CPI?
CPI stands for Consumer Price Index, and it measures changes in price over time. CPI calculates inflation in the USA and other geographical locations.
What causes certificate of deposit (CD) rates to rise?
If your CD has a variable rate, it might rise due to a change in the Federal Reserve’s discount rate(the minimum interest rate that it charges banks to borrow money).
Is putting money in a CD worth it?
With CDs, there is always the risk that the returns won’t be able to keep up with inflation. However, CDs purchased through a bank offer security that other investments don’t, since they are insured by the Federal Deposit Insurance Corp. (FDIC).
The Bottom Line
No matter which method you use to measure inflation, the after-tax return of traditional CDs is no match for the rate of inflation. If you’re intent on investing in CDs due to a low tolerance for risk, consider some CD products that can potentially boost your returns without sacrificing safety.
For example, indexed CDs offer higher potential returns with the principal guarantees of a CD. Indexed CDs are linked to a market index, such as the S&P 500, which pays an interest rate that fluctuates with the market. The rate is usually capped on the upside; if the market index shows a loss, you’ll still receive a minimum interest rate. These are more complicated than traditional CDs, but they can offer safety-conscious investors the best of both worlds.
FAQs
By some measures, CDs may be able to keep up with inflation. However, your actual purchasing power is based on your income after taxes. The interest earned from CDs held outside of a qualified retirement plan is taxable as ordinary income, so the net return of CDs is reduced by your effective tax rate.
Are CDs going to keep going up? ›
Currently, national average rates for a 1-year CD sit at 1.86% APY, up from 0.15% APY in April 2022. But with no change to rates since December 2023, it doesn't appear rates will continue to go up, at least significantly.
Will CD rates stay high in 2024? ›
Projections suggest that we may see no rate increases in 2024, and that the Fed might start dropping its rate later this year, according to the CME FedWatch Tool on April 30. If the Fed rate drops, CD rates will likely follow suit, though it's up to each bank and credit union if and when that occurs.
Is it good to buy CDs during a recession? ›
During the Great Recession and its aftermath, the stock market went through turbulent shifts, resulting in great losses for some stockholders. CDs are one option that can help protect your investment from times of turmoil by providing a stable income.
Should I lock in a CD now or wait? ›
Waiting to open a CD could mean missing out on some stellar rates. Now, you can lock in high rates on both short-term and long-term CDs, and you can score some serious interest just by opting to deposit a larger lump sum into your CD.
Is it worth putting money in a CD right now? ›
If you don't need access to your money right away, a CD might be a good savings tool for you in 2024 while average interest rates remain high. CD interest rates are high in 2024 — higher nationally, on average, than they've been in more than a decade, according to Forbes Advisor.
Can you get 6% on a CD? ›
You can find 6% CD rates at a few financial institutions, but chances are those rates are only available on CDs with maturities of 12 months or less. Financial institutions offer high rates to compete for business, but they don't want to pay customers ultra-high rates over many years.
Where can I get 7% interest on my money? ›
7% Interest Savings Accounts: What You Need To Know
- As of May 2024, no banks are offering 7% interest rates on savings accounts.
- Two credit unions have high-interest checking accounts: Landmark Credit Union Premium Checking with 7.50% APY and OnPath Credit Union High Yield Checking with 7.00% APY.
Are CDs safe if the market crashes? Putting your money in a CD doesn't involve putting your money in the stock market. Instead, it's in a financial institution, like a bank or credit union. So, in the event of a market crash, your CD account will not be impacted or lose value.
What is the best CD rate for $100,000 today? ›
Compare the Highest Jumbo CD Rates
| Institution | Rate (APY) | Minimum Deposit |
|---|
| GTE Financial | 5.38% | $100,000 |
| Credit One Bank | 5.35% | $100,000 |
| Third Federal Savings & Loan | 5.25% | $100,000 |
| CD Bank | 5.25% | $100,000 |
13 more rows"Shorter CD rates won't collapse and will still offer far higher yields than the ones we experienced in 2021 and prior years," Krumpelman says. "Even in 2025, we expect short CDs to pay more than 3%."
How to avoid tax on CD interest? ›
How to avoid taxes on CD interest. One way to postpone being taxed on CDs is to put them in a tax-deferred individual retirement account (IRA) or 401(k). As long as money placed in a traditional IRA is below the annual contribution limit, interest you earn may be tax deductible.
Why is CD not a good financial investment? ›
Banks and credit unions can penalize savers who withdraw CD funds before maturity. CD rates may not be high enough to keep pace with inflation when consumer prices rise. Investing money in the stock market could generate much higher returns than CDs.
Are CDs safe if bank collapses? ›
The FDIC Covers CDs in the Event of Bank Failure
But the recent regional banking turmoil may have you concerned about your investment in case of a bank failure. CDs are treated by the FDIC like other bank accounts and will be insured up to $250,000 if the bank is a member of the agency.
What is the biggest negative of putting your money in a CD? ›
You could get stuck with a lower interest rate than what becomes available. Savings account and CD interest rates can fluctuate. With a savings account, your money will automatically start earning a higher return if interest rates go up. With a CD, however, you'll be stuck with whatever rate you locked in initially.
