Tempted to stash your money in a bank certificate of deposit (CD)? Or maybe under your mattress? Think either one of them will keep pace with inflation? Think again.
Inflation
Inflation is defined as an increase in the general level of prices for goods and services. Deflation, on the other hand, is defined as a decrease in the general level of prices for goods and services. If inflation is high, at say 10% – as it was in the 1970s – then a loaf of bread that costs $1 this year will cost $1.10 the next year.
Currently, the inflation rate in the US is very high. Historically, inflation in the US has averaged 3.3% from 1914 until 2021, but it reached an all-time high of 23.7% in June 1920 and a record low of -15.8% in June 1921.
So how does inflation affect your retirement savings? The answer is simple: inflation decreases the purchasing power of your money in the future. Consider this: at 3% inflation, $100 today will be worth $67.30 in 20 years – a loss of 1/3 its value. Said another way, that same $100 will only buy you $67.30 worth of goods and services in 20 years. And in 35 years? Well your $100 will be reduced to just $34.44.
Bank CDs
A certificate of deposit – a CD – is what's known as a time deposit account – a bank agrees to pay interest at a certain rate if savers deposit their cash for a set period of time. Generally speaking, the interest rate paid by the bank increases as the term (the length of time the bank has your money) increases. CDs are also insured by the Federal Deposit Insurance Corporation for banks and by the National Credit Union Administration for credit unions.
As the chart below shows, CD-yields have been in a steady decline for the past 35+ years:
More specifically, compare three dates from 1984, 2017 and 2022 to see the disparity:
The Mattress
Surprisingly, we all know people who prefer to keep their savings under a mattress or in a shoe box hidden away in a closet. But here is what a world-renowned study of every investor who hid their money under a mattress or in a shoe-box found:
Unfortunately, there was not enough data going back more than 100-years, but I suspect the returns would have been the same.
The Stock Market
If you are looking for average stock market returns over a long period of time, you are likely to get different numbers from different sources. This is because your answer really depends on a number of variables, including which index you review, whether dividends are included or not, whether the effects of inflation are calculated, etc.
Most financial professionals would agree, however, that the long-term data for the stock market points to an average annual return of about 10%. In fact, the S&P 500 has returned a historic annualized average return of 10.5% since its 1957 inception through 2021.
And let’s not forget what 2021 brought investors:
- The DJIA rose 18.7% in 2021;
- The S&P 500 rose 26.9% in 2021;
- NASDAQ rose 21.4% in 2021; and
- The Russell 2000 Index rose 13.7% in 2021.
What Investors Need to Remember
Although there are times when buying a CD might be appropriate, generally speaking, buying CDs should not be part of your long-term retirement strategy – unless you happen to be very close to retirement age. CD rates today just don’t keep pace with inflation. And putting your money under a mattress may be worse (and probably uncomfortable too).
Instead, consider exploring the thousands of financial products that provide a range of options. And remember that over long-periods of time, the stock market has outpaced inflation, today’s CD yields and hiding your money under your mattress.
But before you invest in anything, consider the risk/reward tradeoff, your goals and your time horizon.
Important Disclosures
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual security. To determine which investment(s) may be appropriate for you, consult your financial professional prior to investing.
Investing in stock includes numerous specific risks including: the fluctuation of dividend, loss of principal and potential illiquidity of the investment in a falling market.
Past performance is no guarantee of future results.
CD’s are FDIC Insured and offer a fixed rate of return if held to maturity.
Inflation is the rate at which the general level of prices for goods and services is rising, and, subsequently, purchasing power is falling.
Deflation is a general decline in prices, often caused by a reduction in the supply of money or credit.
S&P 500 Index: The Standard & Poor's (S&P) 500 Index tracks the performance of 500 widely held, large-capitalization US stocks.
Dow Jones Industrial Average (DJIA): A price-weighted average of 30 blue-chip stocks that are generally the leaders in their industry.
The NASDAQ-100 is composed of the 100 largest domestic and international non-financial securities listed on The Nasdaq Stock Market. The Index reflects companies across major industry groups including computer hardware and software, telecommunications, retail/wholesale trade and biotechnology, but does not contain securities of financial companies.
The Russell 2000 Index is an unmanaged index generally representative of the 2,000 smallest companies in the Russell Index, which represents approximately 10% of the total market capitalization of the Russell 3000 Index.
All information is believed to be from reliable sources; however LPL Financial makes no representation as to its completeness or accuracy.
This article was prepared by FMeX.
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