What are Inflation-Linked Certificates of Deposit
Inflation-linked certificates of deposit are federally-insured debt securities that are similar to regular certificates of deposit (CDs), but provide investors with inflationary protection via annually variable interest rates that increase or decrease with changes in the consumer price index, a measure of inflation.
BREAKING DOWN Inflation-Linked Certificates of Deposit
Inflation-linked certificates of deposits are useful tools in any investor’s portfolio. As they are insured up to $250,000 by the federal government through the Federal Deposit Insurance Corporation, Inflation-linked certificates of deposit are as safe as cash. But crucially, you will still earn a small return on this money, far higher than if you put your money in a traditional savings account. In exchange for these higher interest rates, inflation-linked CD accounts have a lock-up period, typically ranging from six months to six years. The longer the lock-up period you agree to, the higher the interest rate you will earn on your savings.
What distinguishes inflation-linked certificates of deposits from standard certificates of deposit is that the depositor is paid extra returns based inflation, as measured by an index like the consumer price index. These extra returns protect investors from inflationary risk, and therefore this type of CD offers slightly lower interest rates than regular CDs. This inflation protection together with FDIC insurance of CDs makes for very safe investments. An investor will never realize huge gains with these securities, but they may play a role in a diversified portfolio or serve as an ideal investment for risk-averse investors
Inflation Risk and Inflation-linked Certificates of Deposit
Inflation-linked certificates of deposit are valuable tools for investors during times of higher inflation, or the decline over time of the value of a dollar. The Federal Reserve maintains a target of 2% inflation annually, though since the financial crisis inflation has regularly been less than that. Many economists believe, however, that as the unemployment rate falls, it will lead to wage increases and inflationary pressure elsewhere in the economy. If significant inflation does return to the U.S. economy, inflation-linked certificates of deposit are one strategy for protecting your savings from falling in value due to inflation.
Many investments, like shares of companies or real estate, are naturally protected from inflation. If prices rise throughout the economy, the prices of these assets will increase inversely to the falling value of the dollar. Debt investments and savings accounts, however, are denominated in dollars as they were valued at the time of the investment. Therefore, investors in certificates of deposit or other types of debt instruments should be wary of inflation risk.