Will Inflation Affect Your Savings Account?

The rate of inflation is inching up again in the U.S. Learn what this could mean for investments, savings accounts, CDs, and money market accounts.
By Gina Pogol

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Americans' long inflation holiday has ended. The US Labor Department recently reported that consumer prices rose 5.4% over the past year -- the worst rate since August 2008. And the core inflation rate, which excludes food and energy prices, rose 4.5% in the past year, the most significant increase since November 1991.

You may have noticed that your paycheck doesn't go as far as it used to. But what's happening to your savings? Will the interest rate for your certificate of deposit (CD) or savings account rise when inflation increases? Is there a way to stay ahead of inflation?

Understanding Inflation

Inflation simply means that the average price for a wide range of goods and services is increasing over time. If your paycheck this year is the same as it was last year, and prices are higher, you won't be able to buy as much.

Prices increase when:

  • Demand for products or resources exceeds supply

  • It costs more to produce a good or service because wages or raw materials are more expensive

Here is an example of how demand can impact pricing. Oil is a finite resource -- there is a limit to how much of the stuff oil-producing countries extract each year. When demand drops, as it did during COVID lockdowns, oil prices fall. And when demand for oil increases, the way it has because we have resumed traveling and commuting, the price goes up.

Energy prices drive a lot of inflation. When oil becomes expensive, it costs more to produce petroleum-based products and to ship all products to consumers. So manufacturers and retailers raise prices to protect their profits. Consumers feel the squeeze and demand higher wages.

Inflation would not be a problem if wages and interest rates increased at the same rate as consumer prices. The effect of inflation would be neutralized. But inflation becomes a problem when wages and savings interest rates fail to keep up.

How Inflation Affects Savings and Other Deposit Accounts

Inflation does not just reduce the power of your current paycheck -- it can also erode your future purchasing ability. Inflation can sneak up on you and slowly drain your savings. If you left $100,000 in an account earning .5%, and the inflation rate was a steady 4.5%, you'd lose 4% per year. Over five years, that would be nearly $18,000 in lost purchasing power. You'd have to earn 4.5% on your savings just to stay even.

Currently, you'll have a hard time keeping up with inflation at today's savings interest rates. The Federal Deposit Insurance Corporation (FDIC) publishes national average interest rate data each month, and these are the average rates on deposits as of July 19, 2021:

Product

Avg Rate

Savings

0.06%

Interest Checking

0.03%

Money Market

0.08%

1 month CD

0.03%

3 month CD

0.07%

6 month CD

0.09%

12 month CD

0.14%

24 month CD

0.17%

36 month CD

0.20%

48 month CD

0.21%

60 month CD

0.26%

That looks like bad news for savers. Even if you tie your money up for five years, you'd earn only a .26% rate with an average account. Fortunately, this scenario is likely to be short-lived.

How to Keep Your Savings Safe

If the economy continues to gain strength, or inflation becomes more than just a temporary blip, the Federal Reserve will probably alter its policies. And then we'll finally see some higher rates on CDs and savings accounts in 2022 or possibly the end of 2021. Currently, banks have more savings than they need and so there is little incentive for them to increase what they pay.

Until that happens, you can safeguard your savings with these tips:

  • Don't commit your savings to accounts or CDs that pay low interest rates and tie up your money for years. You're not giving up much by keeping cash liquid right now, and rates are likely to rise over the next few months. Currently, a 60-month CD pays little more than a 12-month CD.

  • Keep only what you need for emergency savings in completely liquid funds. Explore higher yielding options (like a high-yield money market account with a larger minimum balance) for the rest of your money.

  • Many online banks dropped their interest rates recently. However, most still pay more than traditional banks, and some pay a lot more than others. Find an online bank that pays more than you're getting now -- every little bit helps.

  • Laddering CDs -- buying them in a range of terms to increase your overall yield -- isn't a great strategy right now because even long-term CDs are not paying much. Keep researching rates, however, because yields will rise if inflation catches a gear.

  • Consider TIPS -- Treasury Inflation-Protected Securities. TIPS pricing moves with the Consumer Price Index and these securities are a valid hedge against inflation. And they are government-backed, so their risk is low.

  • Invest in tangible assets like gold or commodities to hedge against inflation. You don't have to actually buy gold bricks or pork bellies to make this work -- try mutual funds that invest in commodities, precious metals, and the energy sector.

  • Explore real estate investing. Rents typically increase with inflation, and if you finance the purchase with a mortgage, you benefit even more. That's because mortgage rates are still near 3%, lower than inflation. It actually pays to borrow under those conditions.

  • Avoid long-term bonds, which can be absolutely hammered if inflation is higher than expected or sticks around longer than projected.

  • Stocks do well when economies heat up and inflation becomes a concern. However, they can be risky in the short term. Minimize that risk by diversifying across different sectors (the ones that perform well under inflationary conditions include food, energy, and household goods) with highly-rated mutual funds.

  • If you're planning to retire in the next few years, putting all of your money into risky investments to increase your return could backfire spectacularly. Be careful.

  • Look for another job. If your paycheck is not keeping up with inflation, chances are another firm is offering more to attract good employees.

  • Don't panic. The Federal Open Market Committee (FOMC) still believes that most of the price increases we're seeing today are temporary, resulting from supply chain problems and labor shortages related to child care availability. This isn't the 1970s.

FAQs

Is inflation good for anything?

Inflation stimulates economic growth. If prices didn't rise, companies would not be able to afford wage increases, and hiring would be more difficult. Inflation also incentivizes consumers to borrow and spend and keeps the economy progressing. As long as inflation is reasonably low and predictable, wages and interest rates keep up and the economy can grow in a healthy manner.

What are some ways to make money during inflation?

Inflation is particularly kind to those who have loans with fixed interest rates. Landlords with mortgages, for instance, can raise their rents but their mortgage payment remains the same. Commodities, real estate, and companies that sell consumer staples like foods and beverages, household goods, personal care products, alcohol, and tobacco all tend to do better.

How can you tell when inflation is happening?

The most well-known measure of inflation is the Consumer Price Index, or CPI. As long as the CPI increases at about 2% per year, policymakers consider that an acceptable inflation rate. Note that prices for specific items like gasoline or food might rise but inflation might not be present -- it must be generalized across many products and services.

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