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CD rates: 3 tips for beating the moving inflation target

March 21, 2011

| MoneyRates.com Senior Financial Analyst, CFA

A rising rate of inflation gives even the best CD rates a higher hurdle to clear. This moving inflation target should affect how you shop for your next certificate of deposit.

Inflation and CD rates

According to the Bureau of Labor Statistics, inflation for the year ending Jan. 31, 2011 was 1.6 percent. This rate of increase in the Consumer Price Index sets the bar for all deposit rates: Exceed the rate of inflation and you are gaining purchasing power, fall behind inflation and you are losing it.

Unfortunately, it has become very difficult for depositors to clear this hurdle. FDIC figures on average CD rates from around the country show that only five-year CD rates average more than the 1.6 percent inflation rate--and just barely, at 1.65 percent. Shorter-term CD rates get progressively lower, on down to 0.14 percent for one-month CDs.

On the surface, this makes for a clear choice when choosing a CD: go long, or give up money to inflation. Unfortunately, the choice isn't quite that simple, because there is no guarantee that the inflation rate will stay at 1.6 percent.

What's next for inflation?

The wave of popular revolutions that have created uncertainty in the Middle East and pushed oil prices higher are just the latest cause of inflation pressure.

As is often the case, the uncertainty may be worse than the reality here. Libya is the current focus of concern about lost oil production, but according to the CIA World Handbook (yes, that CIA), Libya only accounts for 2.05 percent of world oil production. Given that oil production is somewhat flexible (for example, OPEC regularly controls the flow by setting quotas), it should not have an extreme effect on world oil prices if the Libyan supply were to be temporarily disrupted.

Even so, the reality is that at 1.6 percent, inflation is still very low by historical standards. While we may not be facing the extreme spike in inflation that some people fear, the odds seem to favor inflation continuing to rise.

Finding the best CD rates under these conditions

With inflation already higher than most interest rates on CDs, and still rising, what is the strategy for finding the best CD rates?

Here are three approaches to consider:

  1. Go long--with a catch. Since five-year CD rates are the only ones currently beating inflation, this would seem like a natural choice, but if inflation continues to rise, this would leave you unable to adjust if interest rates on CDs also started to rise. The answer is that if you decide to go long, look for CDs with relatively mild penalties for early withdrawal.
  2. Go big. You can get a little more interest if you can afford a jumbo CD--one in excess of $100,000. Premiums for jumbo CDs are pretty small right now, but every little bit helps when you are fighting inflation.
  3. Go for the best. At all standard CD lengths, from one month to five years, you can add a considerable amount of yield by shopping for the best CD rates. It is especially important not to settle for average at a time when average is barely beating inflation.

Inflation is a depositor's enemy, and a very active one. Fighting that enemy requires an equally active approach.

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