Alright, gather round. This is going to be important.
Is a CD really worth it?
In the last article we talked about CDs (certificates of deposit), but you’re probably wondering if it’s really worth it. It takes some real effort to research and buy a CD, and then your money is frozen away for however long and you can’t touch it. Why all the bother then? Well, in a nutshell, the extra effort is worth it to protect your savings from inflation!
Wait, I’ve heard about inflation in the news a lot. What is it?
It’s…a bit complicated. For now, just understand that it means prices go up (hopefully slowly) over time. More on that in a different article though.
Inflation makes prices go up over time, and that means it takes more of your dollars to buy the things you were already buying. So, for example, you take home $10 today and a loaf of bread costs $1. So, after working 1 day, you can buy 10 loaves of bread. In a year though, due to inflation, that bread is now $1.05 per loaf, but you still only make $10 a day. So, before inflation, you could buy 10 loaves of bread per day, but now you can only buy 9 loaves, with a little change left over. With the same amount of money, you can buy less than you did before, because prices rose and your income didn’t.
Right, so now I can afford less just because prices went up. Then how does the CD help protect against this inflation?
Because buying a CD is a little like giving yourself a raise. By buying a CD, you make more money than you used to, thanks to the interest the CD is paying, even if your day job isn’t paying you more. So, even if prices go up, if your income goes up too, you can still afford the same amount of stuff as you used to! Basically, you guarantee your income increases, even if you don’t get a raise. And the coolest part? You don’t have to do any extra work to get this additional money from interest! The CD does all the work for you!
Uh…interest rates, inflation, CD? What are you talking about?
An example of why buying a CD is worth it.
Let’s say you take your $10 you earned today and just stuff it under the mattress. What does it do in there, besides getting super flat and taking on a weird smell? Well, nothing! It just sits there. What does inflation do to prices during that same time? Make them go up! So, in a year, that $10 has done nothing and inflation has been hard at work making prices go up. This means that $10 lost value stewing under your mattress! What can you do instead, so that your money doesn’t just sit there, losing value? Invest it in a CD!
The CD purchase earns money for you from interest. This means that, after the CD matures in a year, you’ll have the original money you put into the CD, plus all the interest you got paid during the year. Your CD was hard at work growing your money, just like inflation was hard at work increasing prices! As a result, your original $10 can still buy the same amount of stuff after a year as it does right now, even if inflation causes prices to go up! That’s important and bears repeating:
Properly investing your money means that you can buy the same amount of stuff in the future as you can today, even if prices go up.
Should you buy a CD now or wait?
Okay got it. So if I invest the money, then I grow the money, and I can buy the same stuff in the future as I can today, even if inflation makes prices go up. So should I buy a CD now or wait, in case interest rates rise, or inflation drops?
Great question, you should buy a CD now, if you can afford it. Simply put, inflation is relentless. It will not stop and the best you can hope for is that it doesn’t go over 2% per year. You can’t control inflation and you can’t fight it. All you can do is make sure your money is growing enough to keep up with (and hopefully grow faster) than it. If you’re not planning to spend the money, still keep it invested as much as possible! Inflation doesn’t take a break and neither should your money.
CDs, specifically, are a great option to keep up with inflation, as they are basically risk free and usually equal or exceed the inflation rate in earnings. As long as your money keeps making money, inflation can’t hurt how much your money is really worth, in terms of what you can buy.
Makes sense. I’ve got about a million questions about inflation though. Can I ask them?
Sure! Next time.
Thanks for reading.
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