If you’re a retiree living off your savings, you won’t be able to maintain the same quality of life if inflation continues to erode your purchasing power. This is notably true in the United States, where medical costs tend to climb faster than other prices.
Can you beat inflation with savings accounts?
Learn about the various methods for making your savings and investments earn high enough returns to outperform growing inflation rates. Inflation is a persistent issue when it comes to saving and investing money. Inflation is lowering your savings and investment returns, even if you are making money.
What happens to savings when prices rise?
Most individuals are aware that inflation raises the cost of their food and depreciates the worth of their money. In reality, inflation impacts every aspect of the economy, and it can eat into your investment returns over time.
What is inflation?
Inflation is the gradual increase in the average cost of goods and services. The Bureau of Labor Statistics, which compiles data to construct the Consumer Price Index, measures it (CPI). The CPI measures the general rise in the price of consumer goods and services by tracking the cost of products such as fuel, food, clothing, and automobiles over time.
The cost of living, as measured by the CPI, increased by 7% in 2021.
1 This translates to a 7% year-over-year increase in prices. This means that a car that costs $20,000 in 2020 will cost $21,400 in 2021.
Inflation is heavily influenced by supply and demand. When demand for a good or service increases, and supply for that same good or service decreases, prices tend to rise. Many factors influence supply and demand on a national and worldwide level, including the cost of commodities and labor, income and goods taxes, and loan availability.
According to Rob Haworth, investment strategy director at U.S. Bank, “we’re currently seeing challenges in the supply chain of various items as a result of pandemic-related economic shutdowns.” This has resulted in pricing imbalances and increased prices. For example, due to a lack of microchips, the supply of new cars has decreased dramatically during the last year. As a result, demand for old cars is increasing. Both new and used car prices have risen as a result of these reasons.
Read a more in-depth study of the present economic environment’s impact on inflation from U.S. Bank investment strategists.
Indicators of rising inflation
There are three factors that can cause inflation, which is commonly referred to as reflation.
- Monetary policies of the Federal Reserve (Fed), including interest rates. The Fed has pledged to maintain interest rates low for the time being. This may encourage low-cost borrowing, resulting in increased economic activity and demand for goods and services.
- Oil prices, in particular, have been rising. Oil demand is intimately linked to economic activity because it is required for the production and transportation of goods. Oil prices have climbed in recent months, owing to increased economic activity and demand, as well as tighter supply. Future oil price rises are anticipated to be moderated as producer supply recovers to meet expanding demand.
- Reduced reliance on imported goods and services is known as regionalization. The pursuit of the lowest-cost manufacturer has been the driving force behind the outsourcing of manufacturing during the last decade. As companies return to the United States, the cost of manufacturing, including commodities and labor, is expected to rise, resulting in inflation.
Future results will be influenced by the economic recovery and rising inflation across asset classes. Investors should think about how it might affect their investment strategies, says Haworth.
How can inflation affect investments?
When inflation rises, assets with fixed, long-term cash flows perform poorly because the purchasing value of those future cash payments decreases over time. Commodities and assets with changeable cash flows, such as property rental income, on the other hand, tend to fare better as inflation rises.
Even if you put your money in a savings account with a low interest rate, inflation can eat away at your savings.
In theory, your earnings should stay up with inflation while you’re working. Inflation reduces your purchasing power when you’re living off your savings, such as in retirement. In order to ensure that you have enough assets to endure throughout your retirement years, you must consider inflation into your retirement funds.
Fixed income instruments, such as bonds, treasuries, and CDs, are typically purchased by investors who want a steady stream of income in the form of interest payments. However, because most fixed income assets have the same interest rate until maturity, the buying power of interest payments decreases as inflation rises. As a result, as inflation rises, bond prices tend to fall.
The fact that most bonds pay fixed interest, or coupon payments, is one explanation. Inflation reduces the present value of a bond’s future fixed cash payments by eroding the buying power of its future (fixed) coupon income. Accelerating inflation is considerably more damaging to longer-term bonds, due to the cumulative effect of decreasing buying power for future cash flows.
Riskier high yield bonds often produce greater earnings, and hence have a larger buffer than their investment grade equivalents when inflation rises, says Haworth.
Stocks have outperformed inflation over the previous 30 years, according to a study conducted by the US Bank Asset Management Group.
2 Revenues and earnings should, in theory, increase at the same rate as inflation. This means your stock’s price should rise in lockstep with consumer and producer goods prices.
In the past 30 years, when inflation has accelerated, U.S. stocks have tended to climb in price, though the association has not been very strong.
Larger corporations have a stronger association with inflation than mid-sized corporations, while mid-sized corporations have a stronger relationship with inflation than smaller corporations. When inflation rose, foreign stocks in developed nations tended to fall in value, while developing market stocks had an even larger negative link.
In somewhat rising inflation conditions, larger U.S. corporate equities may bring some benefit, says Haworth. However, in more robust inflation settings, they are not the most successful investment tool.
According to a study conducted by the US Bank Asset Management Group, real assets such as commodities and real estate have a positive link with inflation.
Commodities have shown to be a dependable approach to hedge against rising inflation in the past. Inflation is calculated by following the prices of goods and services that frequently contain commodities, as well as products that are closely tied to commodities. Oil and other energy-related commodities have a particularly strong link to inflation (see above). When inflation accelerates, industrial and precious metals prices tend to rise as well.
Commodities, on the other hand, have significant disadvantages, argues Haworth. They are more volatile than other asset types, provide no income, and have historically underperformed stocks and bonds over longer periods of time.
As it comes to real estate, when the price of products and services rises, property owners can typically increase rent payments, which can lead to increased profits and investor payouts.
In this time of tremendous inflation, where should I place my money?
“While cash isn’t a growth asset, it will typically stay up with inflation in nominal terms if inflation is accompanied by rising short-term interest rates,” she continues.
CFP and founder of Dare to Dream Financial Planning Anna N’Jie-Konte agrees. With the epidemic demonstrating how volatile the economy can be, N’Jie-Konte advises maintaining some money in a high-yield savings account, money market account, or CD at all times.
“Having too much wealth is an underappreciated risk to one’s financial well-being,” she adds. N’Jie-Konte advises single-income households to lay up six to nine months of cash, and two-income households to set aside six months of cash.
Lassus recommends that you keep your short-term CDs until we have a better idea of what longer-term inflation might look like.
How can I keep my investments safe from UK inflation?
Inflation may have dropped in recent months, but savers still have a fight on their hands if they wish to avoid its corrosive effects.
We’ll look at how taking certain risks with your money can help you keep your money’s value above inflation.
Shift longer term savings into equities
You might have some money in a savings account. After all, it’s recommended that you save away roughly six months’ worth of earnings as an emergency fund. However, you may discover that you have more than you require. If that’s the case, think about putting some of it into investments that have a better chance of long-term growth.
Equities have historically been the most successful assets for fighting inflation over the long term but you must be comfortable with your investments rising and falling in value.
Choose your investments wisely
Other investments, if you know where to search, can produce returns that are higher than inflation. Bond funds, for example, could be included in a portfolio of investments because they invest in debt issued by governments and/or enterprises seeking to raise financing. Throughout their lives, bonds pay a defined rate of interest, known as the coupon, and should refund the original capital at maturity. To spread risk, bond funds invest in a variety of debt instruments.
A financial adviser can help you create a portfolio that takes advantage of all available investment opportunities.
Maximise tax efficiency
After you’ve figured out how to fight inflation, think about how tax-efficient your assets are. ISAs and pensions are both tax-advantaged vehicles for saving and investing for the long term.
ISAs allow you to save up to 20,000 a year in tax-free growth and income on investments, as well as tax-free withdrawals. Meanwhile, depending on your taxable income, pension payments may be eligible for income tax relief of up to 45 percent.
When you can afford it and while they’re still accessible, it’s a good idea to take advantage of hefty tax breaks over time. This way, you can take advantage of compound growth or earning returns on your returns to help you keep up with inflation.
Seek expert advice
A sound investment strategy should include a diverse portfolio of assets and the use of tax-advantaged investment vehicles.
We can put together a diversified portfolio that is geared to your long-term financial goals, risk tolerance, and inflation protection. Get in contact with us right now to learn more.
How do you protect yourself from inflation?
If rising inflation persists, it will almost certainly lead to higher interest rates, therefore investors should think about how to effectively position their portfolios if this happens. Despite enormous budget deficits and cheap interest rates, the economy spent much of the 2010s without high sustained inflation.
If you expect inflation to continue, it may be a good time to borrow, as long as you can avoid being directly exposed to it. What is the explanation for this? You’re effectively repaying your loan with cheaper dollars in the future if you borrow at a fixed interest rate. It gets even better if you use certain types of debt to invest in assets like real estate that are anticipated to appreciate over time.
Here are some of the best inflation hedges you may use to reduce the impact of inflation.
TIPS
TIPS, or Treasury inflation-protected securities, are a good strategy to preserve your government bond investment if inflation is expected to accelerate. TIPS are U.S. government bonds that are indexed to inflation, which means that if inflation rises (or falls), so will the effective interest rate paid on them.
TIPS bonds are issued in maturities of 5, 10, and 30 years and pay interest every six months. They’re considered one of the safest investments in the world because they’re backed by the US federal government (just like other government debt).
Floating-rate bonds
Bonds typically have a fixed payment for the duration of the bond, making them vulnerable to inflation on the broad side. A floating rate bond, on the other hand, can help to reduce this effect by increasing the dividend in response to increases in interest rates induced by rising inflation.
ETFs or mutual funds, which often possess a diverse range of such bonds, are one way to purchase them. You’ll gain some diversity in addition to inflation protection, which means your portfolio may benefit from lower risk.
How does inflation cause you to lose money?
- When the rate of inflation outpaces the rate of interest generated on a savings or checking account, the investor loses money.
- In the United States, the Consumer Price Index (CPI) is the most widely used method of calculating inflation.
- Many people argue that indexing Social Security payments to the Consumer Price Index (CPI) is insufficient.
- Investing in Treasury Inflation-Protected Securities (TIPS), government I bonds, stocks, and precious metals can help preserve investments from inflation.
Is it possible to lose money in your savings account?
You’re well aware that you need to save money. At the same time, you might be wondering whether savings accounts are worthwhile. After all, the income you earn on these accounts is likely to be less than the interest you spend on your debts, including student loans.
True, putting your money in a savings account may not provide the best financial returns, but it has a place in your overall strategy. If you’re debating whether or not to open a savings account, here are some benefits and drawbacks to consider.
Benefits of a savings account
Savings accounts make it simple to put money aside for a variety of reasons. A savings account has numerous advantages, including the following:
- Simple to open: If you currently have a checking account with a bank or credit union, you can easily open a savings account. You may also quickly start a savings account online.
- Savings accounts are liquid because they deal in cash, so you don’t have to worry about selling investments or performing other complicated transactions to get your money.
- Money in a savings account is extremely accessible. To withdraw money, simply use your ATM card or go to the bank. You may also send money fast and easily on the internet or through a mobile app. Keep in mind that moving money from an online savings account to another account without access to an ATM network may take a few days to complete.
- Protected: One of the biggest advantages of a savings account is that your money is safe. Your money is protected from failures (up to the legal limit) if you put it in a bank with FDIC insurance or a credit union with NCUA insurance, so you don’t have to worry about a significant loss.
Remember that you may set up automated transfers to shift money from your checking account to your savings account quickly and simply. This is a great method to save money without even realizing it.
Disadvantages of a savings account
While there are numerous advantages to maintaining a savings account, there are also some drawbacks.
- Low interest: One of the major drawbacks of a savings account is the low rate of return on your money. Furthermore, the cost of relying on a savings account for long-term financial gain may be larger than you believe. Some would reply, “At least you’re not losing money when it’s in the bank.” Unfortunately, saving money in a savings account might result in a loss of funds if the interest rate does not keep pace with inflation. Credit unions, on the other hand, may provide better interest rates than regular banks, while money market and high-yield online savings accounts often offer even higher rates. For example, a traditional bank’s savings account might pay less than 1% annual percentage yield, whereas an internet account might pay 2%. Keep in mind, however, that these are variable rates that might vary fast and frequently. So, you might open an online savings account with a 2% APY, but six months later, that rate could be significantly lower due to factors such as the federal funds rate being decreased. Overall, you should choose a money market or high-yield account over a regular one if you want to earn the highest return on your deposits.
- Fees: Some financial institutions have minimum balance requirements for savings accounts, and if your balance falls below this amount, you may be charged a fee. Look for banks that don’t have minimum balance requirements so you don’t have to spend to keep your savings account open. Before you join up for any account, make sure you understand any and all costs that may be linked with it, as well as how to prevent them.
- Maximum of six withdrawals: Federal Regulation D requires certain forms of telephone and electronic withdrawals, including up to six transfers per statement cycle from savings accounts. Withdrawals made online or over the phone, rather than in person at a bank or an ATM, are included. If you go above this limit, you may be charged a fee by the bank or credit union, or your account may be canceled altogether. So keep track of your withdrawals to ensure you don’t go over your limit. This is especially important if you have an online-only account with no ATM network or physical locations.
- You may be missing out on alternative, higher-risk but higher-reward methods to make money if you keep too much money in your savings account, such as investing in the stock market. There are a variety of methods that can assist you in investing and achieving larger potential earnings. Stocks, on the other hand, have a far higher potential for serious loss in the event of a market slump. It will be significantly less dangerous to store money in a savings account if you want to keep money on hand for emergencies or if you know you’ll need the money in the near future. Other investments have less liquidity and a more difficult time getting your money back. When you need to sell a stock, for example, you can’t simply withdraw money from an ATM. You’ll also have to think about paying a capital gains tax or selling your shares for less than you paid for it.
So is a savings account worth it?
Savings accounts may appear to be unprofitable from a yield standpoint, especially if you’re repaying bills with higher interest rates, such as student loans.
The advantages of a savings account, on the other hand, are not dependent on your earnings. Instead, think about the purpose of your account, as well as your liquidity and access.
A savings account is perhaps the greatest option for your emergency money. After all, the whole point of having an emergency fund is to be able to access the funds fast when you need them. Some experts advocate keeping at least six months’ worth of living expenses in a savings account, but even a few thousand dollars can aid in an emergency.
A certificate of deposit (CD), which you may purchase from banks and credit unions and which may provide a slightly greater rate than a savings account, is another option. Early withdrawal fees are common with CDs, making them less liquid than a conventional bank account. However, certain banks offer no-penalty CDS, so this is an alternative worth considering.
While you shouldn’t put all of your savings in a low-yield cash account, savings accounts can be part of a larger financial strategy that includes investment and retirement accounts.
Who is harmed by inflation?
According to a new Gallup poll, nearly half of Americans think rising costs have created difficulty for their families, with lower-income Americans “suffering the most.”
Inflation has increased by 7% year over year, a pace that is felt most keenly by those with lower earnings.
Gallup found that two-thirds of lower-income adults those earning less than $40,000 per year have suffered moderate to severe difficulty as a result of increased prices.
Meanwhile, 56 percent of middle-income Americans (those earning $40,000 to $99,000 per year) and 32 percent of upper-income Americans (those earning $100,000 or more) stated they are going through at least moderate hardship.
Gallup also discovered that nearly eight out of ten Americans expect inflation to grow, which is more than typical. (Gallup found that 6 out of 10 Americans expected inflation to rise between 2007 and 2020.)
The findings are similar to those of projects like the Penn Wharton Budget Model, which recently published a report on the impact of inflation on household income. Lower-income households spent around 7% more on goods and services in 2021 than they did in 2019 and 2020, while higher-income households spent roughly 6% more.
The Federal Reserve said Wednesday that it may raise interest rates in March in response to growing inflation; this would be the first time rates have risen in three years.
Is there any benefit to inflation?
- Inflation, according to economists, occurs when the supply of money exceeds the demand for it.
- When inflation helps to raise consumer demand and consumption, which drives economic growth, it is considered as a positive.
- Some people believe inflation is necessary to prevent deflation, while others say it is a drag on the economy.
- Some inflation, according to John Maynard Keynes, helps to avoid the Paradox of Thrift, or postponed consumption.