Inflation-Linked Certificates of Deposit
What Are Inflation-Linked Certificates of Deposit?
As their name recommends, inflation-linked certificates of deposit (CD) are a type of CD whose interest rates are indexed to the rate of inflation. In exchange for this additional protection, inflation-linked CDs generally offer somewhat lower interest rates as compared to traditional CDs.
How Inflation-Linked Certificates of Deposit Work
In contrast to different assets, like real estate or publicly traded shares, debt instruments and savings accounts are named in dollars as they were valued at the hour of the investment. Accordingly, if inflation somehow managed to increase during the term of the investment, this could disintegrate the real value of the principal returned toward the finish of the investment term. Thus, investors who are worried about inflation might wish to consider investment vehicles that have an implicit protection against inflation risk.
Inflation-linked CDs furnish investors with this protection by indexing the CD's interest rate to the consumer price index (CPI), which is a widely utilized measure of inflation. Assuming inflation increases during the CD's term, the increase will be added to the instrument's interest rate, in this way protecting the investor against interest rate risk. These securities are likewise insured for up to $250,000 by the Federal Deposit Insurance Corporation (FDIC), making inflation-linked CDs among the most secure assets that anyone could hope to find to investors.
As is many times the case in investing, the tradeoff to these risk protections is the way that inflation-linked CDs generally offer exceptionally low yields, regularly marginally lower than traditional CDs. One way for investors to increase the interest rate received on their inflation-linked CDs is to consent to lock in their funds for a more drawn out investment period. Ordinarily, the terms for inflation-linked CDs range between six months and six years, with longer periods bringing about higher interest rates.
Real World Example of an Inflation-Linked Certificate of Deposit
Michaela is a real estate investor who consistently trades properties. She is planning to start construction on another real estate development in six months, however is worried that inflation might be on the verge of expanding among sometimes. Since she is worried that inflation could dissolve the real value of her cash holdings, Michaela chooses to invest a portion of her cash into an inflation-linked CD with a term of 6 months.
Toward the finish of the term, Michaela will pull out her funds to assist with funding her forthcoming construction project. Meanwhile, the inflation-linked CD will safeguard her against inflation risk by expanding her interest payments in accordance with any possible increases to the CPI. In exchange for this security, Michaela must focus on keeping her funds inside the CD for a very long time and must likewise acknowledge a somewhat lower starting interest rate than would be accessible from traditional CDs.
Features
- Inflation-linked CDs are a generally low-yielding instrument, however can be a valuable expansion to a diversified portfolio, especially for more risk-cognizant investors.
- Inflation-linked CDs are an investment vehicle that give protection against inflation risk.
- This is achieved by indexing the interest rate on the investment to a measure of inflation, which is normally the CPI.
