While planning and accounting for your savings and investments, we often tend to overlook the effects of inflation on the final amount. Inflation is what makes things expensive – a cup of coffee that was once priced at $1.75 now costs $2.99, a price change that can be attributed to inflation. Your investments are also affected by inflation indirectly – while we will receive predetermined interest on investments, the amount of goods and services you can get with that corpus at a future date is likely to be less than what you can presently get for that amount. This is called the time value of money, which is continuously impacted by inflation. If you don’t plan ahead, your financial goal could be undermined by inflation, and that could have an impact on your future standard of living.
Inflation in the United States is measured by the Consumer Price Index (CPI) which is calculated by the US Bureau of Labor Statistics. Over the years, the CPI averages about 3.5% annually. This means the cost of products is increasing at a rate of 3.5%. This may not seem a lot at first, but calculate it throughout a 30-year retirement plan, and you’ll find that the living costs have doubled more than once. For example, if your yearly expenditure is $10,000, in the future, it is likely to cost you $20,000, or even $40,000, for the same expenses. Of course, everyone wants a better lifestyle than we currently have, and therefore, your costs are going to be that much more.
Limited financials and the corrosive impact of inflation chip away at the real value of your savings and investments. This signifies that you need higher returns for your money to keep your purchasing power intact. How can you prepare for inflationary depression? Read on for tips on how to stay ahead of inflation and protect your wealth from being eaten away.
1) Subscribe to government bonds
Chances are you have invested in some sort of bonds. If you haven’t, you should consider buffering your portfolio with this fixed-income product; it is a great way to minimize the risk in your portfolio. This will also help bring diversification to assets in your investment portfolio. Bonds provide the anchor and the stability needed with investing. However, there’s something about bonds you should know – the fixed income avenue helps to back-calculate the exact amount of earnings you can make in the future, and therefore, you have the opportunity to invest more money to counter the inflationary pressures. The coupon payments in bonds are generally fixed at a certain value.
Say you invested $100,000 in bonds, and you get an annual return of $5,000. Presently, the return may seem reasonably good. But, imagine 10 or 20 years from now – will $5,000 be enough to meet your future expenses when things are more costly because of inflation?
What can you do? You can invest in short-term bonds. Focusing on short-term bonds lessens your exposure to future inflation. You can sell the older bonds as they mature, and invest in new ones. This way, you can benefit from interest rates while also adding to your corpus. It is noteworthy that a reduction in interest rates creates more liquidity in the economy, and that means more spending power, causing inflation to rise! Interest rates and inflation have an inverse relationship.
Read our article on Should You Hold Or Sell Your Long-Term U.S. Government Bonds? for a comprehensive picture of the bond market in the U.S.
Diversify your portfolio, and make way for short-term bonds rather than being locked in with long-term bonds.
2) Purchase Treasury Inflation-Protected Securities (TIPS)
Treasury Inflation-Protected Securities or TIPS are bonds backed by the government and issued by the United States Treasury. TIPS are some of the safest securities in the world as they are free from the risk of default (the U.S. government stands guarantee).
The specialty of TIPS is that the bonds are indexed and linked to an inflationary gauge, mostly the CPI. Rising inflation reduces the purchasing power of money, i.e., we can afford lesser goods and services for the same amount of money than when inflation is low. To minimize this loss of purchasing power and to protect investors’ returns from inflationary pressures, TIPS includes an inflation rider that adjusts the value of your principal in line with the CPI.
If the interest rates increase, the value of TIPS, just like any other bond, can fall temporarily. But, if you’re looking purely for protection against both inflation and any risk of credit default, TIPS may be something you can consider including in your portfolio.
3) Consider adding gold to your portfolio
How many times have you heard the advice to go gold and forget about it? Well, in today’s times, it isn’t as straightforward. While gold does have the feature of keeping its value in the long-term (as there is no depreciation in value involved), in shorter periods, the price of gold can be volatile and trades just like any other stock. A variety of global factors affect the supply and demand of gold that leads to price fluctuation.
Experts recommend that a touch of gold can add balance to your portfolio. Traditionally, gold is renowned for having an inflation-beating capability. This stems from the fact that the value of gold does not depreciate.
However, experts also warn against going all-in on gold. Gold trading isn’t like equity trading; you don’t benefit by holding it – that is, gold does not earn anything as such – there are no interest payouts or dividends earned. And if you purchase the metal physically, i.e., in the form of jewelry, coins, or bars, you have to consider the holding costs and associated risks of theft, burglary, and loss.
Gold is nonetheless hailed as a hedge against inflation; it increases in value as the purchasing power of the dollar declines. Gold ETFs, which are digital versions of gold, is a great alternative to purchasing and storing the physical metal.
4) Invest your cash savings
The necessity and importance of an immediately accessible emergency fund enough to sustain you without income for twelve to sixteen months is a factor that shouldn’t be overlooked. Once you have your emergency fund figured out, you can invest the remainder of your savings for better returns, and to combat inflation.
A lot of people hold on to cash in the form of savings, lying idle in cookie jars or bank spending accounts. However, money begets money when you use that money to make investments. Investment to earn better returns and multiply your wealth acts as a hedge against inflation and rising costs. If you are someone holding on to cash to purchase something big years later, advisors recommend you to look for ways to make that money work for you.
If you want to play very safe, you may explore term deposit accounts, which offer a slightly higher rate. However, you won’t be able to withdraw money for a certain period. For riskier profiles, you can even look at putting the money in equity investments to generate wealth. This brings us to the other way to protect your savings from inflation – equity investment and mutual funds.
5) Investment in equities and mutual funds
Investing in equities and mutual funds is a cost-friendly way to stay ahead of inflation. Stock market securities permit investing very small amounts of money, unlike fixed income products that have minimum entry costs.
If you’re a beginner or a small investor, it’d be wise to start with mutual funds. The risk is diversified and lower, and there is a professional manager in charge of your money. You could also look into consulting with an expert on which funds to pick and how much to invest for your savings to beat inflation.
Confused about where to put your money for optimum returns and minimal risks? Get in touch with a financial fiduciary for all your investment planning needs. Use Paladin’s free matching tool to get connected with 1-3 financial advisors who meet your financial needs.
Equity market investments require more prudent research and expertise to benefit from it. One way to tide over the per-second volatility in price is to consider the investment from a long-term perspective. This would mean holding the stocks for 10-15 years. Historically, stock markets across the world have trended uphill even though the road has been rocky.
Another way you could create wealth to beat inflation is by investing monthly or creating a systematic investment plan (SIPs). Saving and investing will then become a part of your life – a disciplined approach to investing. A long-term investment in equity, through SIPs, allows your money to compound over time and creates a large corpus for your use. Your money will multiply manifolds by the time you reach your retirement. Even if you’re closer to your retirement, it may help to have a small part of your portfolio in equities for its wealth appreciation capability. Ensure you have the risk appetite before making the investment decision.
6) Invest in real estate
Investors who want to protect their savings from inflation in the long term can look at investing in physical assets such as an investment in real estate. Investing in a carefully researched property in a central location or one with growth potential always pays off in the long run.
As inflation increases, the resale value of the property also increases. Let’s not forget the rental income that one can accrue from real estate.
For those of you who wish to invest in properties, chalk out your plan in detail. Study your options. Which location would you want to invest in, and what type – commercial or residential? You should be able to see through the hype of certain sectors and figure out places that will benefit you in your situation. Alternatively, you may also consider REITs – Real Estate Investment Trusts. REITs are indirect investments in real estate through market securities that investors can explore putting their money in.
The Last Word
Inflation is real. Fighting inflation is not very different from sound long-term financial planning. Not taking into consideration and accounting for inflation can have a major impact on your returns from investments.
But this does not necessitate you having to look outside the box to protect your wealth from inflation. Experts say that befriending inflation and making investments that leverage inflation to generate wealth is the wise way to approach beating inflation. Old-school tactics are just as good. Invest for the long-term and you’ll have an excellent plan to not just combat inflation but also diversify and increase your wealth.
Have you considered how inflation could have an impact on your investments and savings? Do you need help protecting your wealth from inflation? Answer a few questions on Paladin’s free match service tool and get matched to 1-3 professional financial advisors who can help manage your wealth. You may set up an interview with the financial fiduciaries before you decide to engage with one.
To learn more about the author William Hayslett, view his short bio.
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The blog articles on this website are provided for general educational and informational purposes only, and no content included is intended to be used as financial or legal advice. A professional financial advisor should be consulted prior to making any investment decisions. Each person's financial situation is unique, and your advisor would be able to provide you with the financial information and advice related to your financial situation.