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Inflation, low CDs hit buying power

By Claes Bell, CFA · Bankrate.com
Monday, November 19, 2012
Posted: 2 pm ET

One the things we write about a lot about on this blog lately is how today's low CD rates mean that money deposited in a CD will actually lose buying power over time.

How much buying power are we talking about? Let's run through a little hypothetical experiment to find out.

Say your favorite thing to buy is Snickers bars, which cost $1 apiece. You really want to make sure you can buy enough Snickers bars in retirement, which starts in five years, so you decide to put $1,000 in a five-year CD timed to mature on the exact day you retire. Like I said, you really like Snickers bars.

Right now, the average five-year CD is yielding 0.93 percent a year, which means that in five years, assuming you reinvest the interest payments, your Snickers fund will be $1,043.37. At today's prices, that would buy you 43 extra Snickers bars, and there is nothing on this planet that makes you happier than free Snickers bars -- so you are pretty much ecstatic.

But there's one little problem: Inflation, as measured by the Consumer Price Index, is currently rising at 2.2 percent per year. Assuming it continues rising at that rate for the next five years, prices will be 11.5 percent higher in five years than they are today. That means your beloved Snickers will cost about $1.12 apiece, and your $1,043.37 will only buy you 939 Snickers bars. Those 61 lost Snickers bars go on to haunt your dreams for years to come, ruining your retirement, and probably, your entire life.

That's the predicament many Snickers-loving savers find themselves in these days, but there are some steps you can take to avoid it. For one thing, you can find five-year CD rates as high as 1.8 percent by shopping around. That won't totally avoid inflation risk, but it will lessen the bite in terms of lost Snickers bars. You could also elect to keep your cash in a liquid savings account and hope rates go up, rather than locking it away at today's low rates.

The other thing you can do is shift some of your savings into I bonds, which are specifically designed to keep up with inflation. You could theoretically cash them in five years from now and not lose a single Snickers bar.

What do you think? Does the gap between CD yields and inflation worry you? Do you even like Snickers bars?

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4 Comments
Vlad G
November 20, 2012 at 1:24 pm

The point of the article is correct, but the numbers are underestimated. The majority of the US population spends the majority of their income on housing, food, and healthcare. Food and healthcare inflation was above 10% and not 2% so the impact on an average family is loss of purchasing power in ranges of over 8% per year. These are just my two cents to add.. The only way out is to balance your income and portfolio to produce provide an increase to your income of 10%+ per year. This way better than countries in Africa, but times of sustaining your standard of living by just going to work are long gone.