Certificates of deposit (CDs) pay you a fixed interest rate over a specific duration of time that can range from three months to five or more years. Because you lock in a rate for a long time, certificates of deposit are not the best investment option when inflation is on the rise because you might lose out on other investments that would better keep up with the rising cost of living. Here's what you need to know about CDs and inflation, as well as some possible alternatives.

How Rising Inflation Affects CDs

CDs, unfortunately, are not the ideal investment for an inflationary environment. If the interest rate on a CD can't keep up with inflation, your money loses purchasing power. And because interest rates usually rise when inflation goes up, you could be missing out on better-paying investments while your money is tied up in a CD.

This is especially true of CDs with longer terms. While paying somewhat higher rates than short-term CDs, they also lock up your money for a longer period, subjecting it to greater inflation risk. If you want to get your money out before the CD's term ends, you'll typically face early-withdrawal penalties. These penalties can cost you some or all the interest your CD has earned.

There are usually better options available. For example, most high-yield savings accounts (HYSAs) pay about as much as a CD, with no early-withdrawal penalties. And like CDs, they are insured by the Federal Deposit Insurance Corporation (FDIC) or National Credit Union Administration (NCUA).

Depending on how much risk you are willing to take, there are also other alternatives.

Alternatives to Standard CDs

CDs With Adjustable Rates

Two other CD types, variable-rate CDs, and bump-up CDs, may adjust their rates upward, making them more suitable in a period when inflation and interest rates are rising.

• Variable-rate CDs adjust the annual percentage yield (APY) you're paid based on the prime rate or another index.
• Bump-up CDs, also called liquid CDs or step-up CDs, let you choose one time during the CD term when you'd like to adjust your interest rate.
  

These products can give you some inflation protection, but they also have their downsides. One is that they tend to offer a lower initial interest rate than the rate available at that point on a traditional CD. Another, with variable-rate CDs, is that your rate could fall if inflation declines—a particular danger if you happen to buy your CD just as inflation is peaking. Bump-up CDs only go up, however.

I Bonds

The most often recommended alternative to CDs are Series I U.S. savings bonds, commonly known as I bonds. An I bond carries about the same liquidity risk as a CD (you can't cash it out until you've had it for 12 months, and you'll pay a penalty if you withdraw it before five years). And while it isn't FDIC- or NCUA-insured, it has essentially zero risk of default because it is backed by the U.S. government.

I bonds adjust their interest rates every six months in line with inflation. For example, in February 2024, I bonds were offering a composite rate of 6.89%, compared to the best 5-year CD rate in February 2024, which was 5.30%.

I bonds earn interest for 30 years unless you cash them in sooner. There is no penalty for cashing one in after five years but if you cash in before then, you'll pay the last three months' interest as a penalty. You can buy an I bond for as little as $25 or as much as $10,000, per calendar year.

Treasury Inflation-Protected Securities (TIPS)

Other relatively low-risk alternatives to CDs include Treasury inflation-protected securities (TIPS). Like I bonds, TIPS are tied to changes in the Consumer Price Index (CPI), specifically the CPI-U. (They pay a fixed interest rate, but your principal value will increase when inflation rises.) TIPS are available for $100 and up, in $100 increments, and with terms of five, 10, or 30 years. Like I bonds, they are subject to federal tax but exempt from state and local taxes.

Floating-Rate Notes

Floating-rate notes are still another possibility. These are government or corporate bonds with rates that will "float" as the index they're linked to rises or falls. You can buy them through a brokerage firm or in the form of a floating-rate mutual fund or exchange-traded fund.

Getting Out of Your CDs

If you're locked into one or more fixed-rate CDs that are losing ground to inflation, you have several options, none of them ideal.

• You can simply wait until the CD's term ends, take the money, and reinvest it in something else. (Make sure you give your bank or credit union instructions when the time comes, or it may just roll the money over into a new CD, locking you in again.)
• You can take your money out prematurely and pay an early-withdrawal penalty. These penalties can be relatively steep, so you may not come out ahead even if you immediately put the money into a better-paying investment. There is no maximum penalty for early CD withdrawals, as set by the U.S. government.
• If you have a brokered CD purchased from a brokerage firm or independent sales agent, you can get out of it by selling it on the secondary market. However, your CD's lower interest rate will make it less valuable compared with newer, better-paying CDs, and you may have to sell it at a loss.
  

The Bottom Line

While high inflationary environments are never a great thing in general, inflation poses a particular threat to fixed-rate investments like certificates of deposit. If you're looking for a place to invest in a time of inflation there are any number of alternatives, some just as safe as CDs, others a bit riskier.
Series I savings bonds may be a good option for the risk-averse who don't mind locking up savings for at least one year.