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Inflation kills CD rates

By Sheyna Steiner ·
Thursday, May 12, 2011
Posted: 8 am ET

The government measures the amount of inflation consumers experience with the consumer price index, or CPI. If prices are going up for many consumer goods and services, then inflation is likely rising.

The official method of measuring inflation has garnered quite a bit of criticism due to a couple of reasons. For one, the core CPI does not include volatile oil and food prices, which can skyrocket and plummet at will.

Additionally, home prices make up a huge part of the CPI, 42 percent. While home prices are not going anywhere and, in fact, are still falling in many areas, prices for other consumer goods have been rising, notably gas and food.

The most recent core CPI measurement pegged the rate of inflation at 1.2 percent. With food and energy thrown in, the inflation rate is 2.7 percent.

Regardless of the discrepancy caused by lagging home prices, most people's budgets don't allow for stripping out inconveniently volatile prices. So when the cost of oil or milk goes up, consumers feel it in the wallet.

Of course investments end up reflecting the impact of inflation as well. If returns aren't at least keeping up with the rate of inflation, the buying power of that money is reduced.

With today's CD rates, keeping up with inflation is hardly even possible. Once you factor taxes into the mix, it doesn't look good for CD investors.

While CDs are very safe in that you won't lose your principal, they are not without risk and today's environment highlights that. Relying on one type of savings or investment vehicle is risky; using many different investments can increase your returns while reducing the risks associated with putting all your eggs in one basket.

In today's world, there isn't one magic bullet that can take care of all of our investing needs -- though mutual fund companies are certainly trying. CD rates will remain low for a while but diversifying across asset classes is the best way to reduce risk, in any of its many forms: interest rate risk, market risk and inflation.

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