CD Rates: The Best Bad Option?

Traditionally, when you let someone use your money, either by lending it to them or depositing it with a bank, you could count on getting back a little more than the rate of inflation. This is only fair--it means the value of your money has kept up with rising prices, plus you've gotten a little extra for lending it out.

Lately, though, that kind of fair deal has been nearly impossible to find. Even if you are willing to lock up your money in a CD, you can't expect to be well rewarded for your troubles. Interest rates on CDs aren't close to keeping up with inflation, let alone rewarding you for your commitment. The only reason people keep signing up for this kind of deal is that the alternatives are even less appealing.

A year's worth of interest lost to inflation--in one month

August's rise in the Consumer Price Index (CPI) offered a graphic example of the mismatch between inflation and CD rates these days. According to the FDIC, average 1-year CD rates are 0.38 percent. In August, the CPI rose by 0.40 percent.

That means that the average 1-year CD lost an entire year's worth of interest in a single month. What makes this especially troubling is that recent inflation trends suggest this was no fluke.

Troubling inflation trends

Here are three reasons the inflation picture is more threatening than just an isolated bad month:

1. Inflation numbers in five of the last seven months have exceeded 0.4 percent.
2. The year-over-year rate of inflation has now risen to 3.8 percent.
3. Inflation, which began in the energy sector, has now spread to other key sectors, such as food and apparel. Apparel price increases have exceeded 1 percent for each of the past four months.

In short, the economy may be faltering, but inflation seems to be gathering steam.

A silent bail-out?

The Federal Reserve is supposed to manage monetary policy to both keep a lid on inflation and promote economic growth. Lately, though, the Federal Reserve has assured the public that inflation is not a concern, and they've kept their entire focus on promoting economic growth. This has included keeping interest rates artificially low.

Meanwhile, inflation has continued to rise. Is the Fed asleep at the switch? Not likely. They are simply content to let inflation run ahead of interest rates for a while. This is a winning proposition for debtors, because the money they owe is being devalued by more than the interest they have to pay. Given the number of Americans with debt problems--the government itself has this problem--the Fed is silently bailing out debtors by letting inflation exceed interest rates.

So why would anyone sign up for today's CD rates? Because it may not be as bad as the alternatives. Stocks have shown themselves prone to sudden reversals, and speculating in commodities like gold is an even riskier prospect. Buying bonds means not only signing up for low interest rates, but risking having principal decline if interest rates rise.

In short, CDs are still a viable alternative in an ugly financial climate. The best favor you can do for yourself is to shop around for the best CD rates to cut into inflation's advantage as much as you can.

 

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