Inflation has been a central focus in recent years, capturing headlines and influencing economic decisions. While the rate of inflation has retreated from its 40-year peak of 9.1% observed in 2022, it still surpasses the Federal Reserve’s long-term target of 2%, a benchmark considered optimal for fostering employment and sustaining price stability.
Inflation doesn't just impact the economy at large; it also challenges the average consumer’s ability to build and preserve their wealth. In this week’s blog, we’re looking into how inflation affects your retirement nest egg and explore strategies to mitigate its impact.
Inflation is the increase in the prices of goods and services over time. Inflation cannot be measured by an increase in the cost of one product or service, or even several products or services. Rather, inflation is a general increase in the overall price level of the goods and services in the economy. High inflation indicates rapid price growth, while low inflation signifies slower price increases.
It is calculated by dividing the change in price by the starting price, then multiplying by 100. The formula is:
Inflation Rate = ((B-A)/A) x 100
For instance, if a carton of eggs costs $4 now and was $3.50 a year ago, the inflation rate can be calculated as follows:
($4 - $3.50) / $3.50 x 100 = 14.29%
However, inflation typically encompasses more than just egg prices, it also affects a broad range of goods and services like groceries, healthcare, utilities, and even your personal nest egg.
The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. The CPI is the most widely used measure of inflation and is sometimes viewed as an indicator of the effectiveness of government economic policy.
The primary way inflation harms your wealth is by eroding the purchasing power of your money. If your savings do not grow at a rate that outpaces inflation, you will effectively lose money in terms of what it can buy.
Inflation is particularly damaging to fixed-income investments such as bonds and savings accounts. These investments typically offer a fixed return, and if inflation rates rise above the interest rates on these investments, your real return can become negative.
As inflation increases, so does the cost of living. This means you need more money to maintain the same standard of living. Without proper adjustments to your income or investment strategy, you might find it challenging to keep up with these rising costs.
1. Invest in Stocks
Investing in stocks can be an effective way to protect your wealth against inflation, as equities have historically provided returns that outpace inflation over the long term. Companies often have the ability to increase prices for their products and services, which can lead to higher revenues and profits, translating into potential gains for shareholders.
However, it's important not to rely solely on stocks for inflation protection, as they can be volatile and subject to significant short-term fluctuations. Diversifying your investment portfolio with other asset classes can help mitigate risks and provide a more balanced approach to safeguarding your wealth against inflation.
2. Real Estate Investments
Property values and rental income generally rise with inflation, potentially providing a hedge against the diminishing purchasing power of money. This has many people wondering if now is the right time to invest in real estate. Although rising interest rates increase the financing costs for real estate investments, potentially discouraging investors, they often lead to higher rents, which can make it a favorable time to enter the market. While there’s no perfect time to invest, there is a most favorable time based on your objectives.
Historically, investing in real estate was seen as a domain for affluent investors. However, with the advent of Real Estate Investment Trusts (REITs), everyday investors now have a pathway into the industry. REITs handle the complexities of property management and distribute the profits to shareholders, allowing you to enjoy a passive income stream through regular dividend payouts. This setup frees you from the responsibilities of tenant vetting, damage repairs, and overdue payments, making real estate investment more accessible and manageable for everyone.
3. Treasury Inflation-Protected Securities (TIPS)
TIPS are a type of U.S. Treasury security specifically designed to protect against inflation. The principal value of TIPS increases with inflation, as measured by the Consumer Price Index (CPI), helping ensure that your investment keeps pace with rising prices. As inflation rises, the principal of TIPS increases, leading to higher interest payments, which are calculated on adjusted principal. This unique feature helps ensure that returns keep pace with inflation, providing a reliable defense against the diminishing purchasing power of your money.
Available in maturities ranging from 5 to 30 years, TIPS pay interest semiannually. These interest payments vary with inflation, increasing during periods of high inflation and decreasing when inflation is low. At maturity, investors receive the greater of either the adjusted principal or the original principal, offering potential protection against the loss of principal due to inflation.
4. Commodities
Investing in commodities such as gold, silver, and other raw materials can be a highly effective strategy for hedging against inflation. These tangible assets often maintain their value or even appreciate during periods of high inflation, potentially serving as a protective buffer for your savings.
Commodities have intrinsic value and are less susceptible to devaluation which can affect fiat currencies and other financial instruments during inflationary times. For instance, gold and silver have been historically recognized as safe-haven assets, attracting investors when economic uncertainty and inflationary pressures rise. Additionally, other raw materials like oil, agricultural products, and industrial metals are essential for various industries, and their prices tend to increase with rising demand and inflation.
5. Diversify Your Portfolio
Diversification is a fundamental strategy for managing risk, including the risk posed by inflation. Spreading your investments across various asset classes can help you mitigate the adverse effects that inflation can have on your overall portfolio. Different asset classes, such as stocks, bonds, real estate, commodities, and cash equivalents, respond differently to economic conditions, including inflationary pressures.
By allocating your assets among different classes, you create a balanced portfolio that can better withstand the fluctuations and uncertainties of inflation. This approach helps reduce the risk that any single asset class will negatively impact your overall financial health, helping ensure a more stable and resilient investment strategy. Diversification also provides flexibility, allowing you to adjust your investment mix in response to changing economic conditions, ultimately helping you achieve long-term financial stability and growth.
6. High-Yield Savings Accounts and CDs
High-yield savings accounts and Certificates of Deposit (CDs) can help mitigate the impact of inflation on your savings. Traditional savings accounts often offer minimal interest rates that don't keep up with inflation, resulting in a loss of purchasing power. In contrast, high-yield savings accounts provide significantly higher interest rates, helping your savings grow at a more competitive pace. Comparing rates from various financial institutions, particularly online banks and credit unions, can help you find the best options. These accounts offer the same liquidity and security as regular savings accounts, potentially making them a safe and flexible choice for your cash reserves.
CDs offer higher interest rates than regular savings accounts in exchange for locking your money away for a specified term. The longer the term, the higher the interest rate, providing a steady growth rate for your savings. To help maximize benefits, consider creating a CD ladder, and purchasing multiple CDs with varying maturity dates to maintain regular access to your funds while enjoying higher interest rates for longer terms. Incorporating high-yield savings accounts and CDs into your financial strategy offers a low-risk component that helps balance more volatile investments, contributing to a well-rounded approach to financial stability and growth.
Inflation poses a significant threat to your savings and investments, potentially eroding the purchasing power of your nest egg over time. At NJM Wealth Preservation Strategies, we understand the importance of safeguarding your wealth against inflation while simultaneously helping grow it to meet your long-term financial goals, including retirement. Here’s how we can help:
We’re experienced in crafting investment strategies that are resilient to the effects of inflation. By diversifying your portfolio with assets such as stocks, real estate, Treasury Inflation-Protected Securities (TIPS), and commodities, we aim to shield your investments from the erosive impact of rising prices. Our team diligently monitors economic trends and adjusts your portfolio accordingly to help ensure it remains well-positioned to withstand inflationary pressures.
Beyond inflation protection, we are dedicated to helping you grow your wealth over time. Our experienced financial advisors work closely with you to develop personalized investment plans tailored to your risk tolerance, financial objectives, and time horizon. Whether you’re seeking capital appreciation, regular income, or a combination of both, we identify opportunities in the market that align with your goals, helping you maximize returns and build a more prosperous financial future.
Planning for retirement is a cornerstone of financial security, and NJM Wealth Preservation Strategies is here to guide you every step of the way. We take a holistic approach to retirement planning, considering factors such as your desired lifestyle, retirement age, expected expenses, and risk tolerance. Through careful analysis and strategic asset allocation, we design retirement income strategies aimed at providing you with a comfortable and sustainable income throughout your golden years. Whether you’re decades away from retirement or nearing the end of your career, we provide ongoing support and guidance to help you navigate the complexities of retirement planning with confidence.
Inflation is an inevitable part of the economic landscape, but it doesn’t have to erode your wealth. By understanding what inflation is and why it’s detrimental to wealth growth, you can take proactive steps to help protect your assets.
It’s key to stay informed on market trends, plan ahead, and ensure your financial strategy is robust enough to withstand the test of time.
For personalized guidance on protecting your wealth from inflation, consider consulting with Wealth Preservation Specialist, Nic J. McLeod and our wealth preservation team. At NJM Wealth Preservation Strategies, we specialize in helping you safeguard your assets and secure your financial future. Contact us today to learn more about how we can help you stay on track with your financial goals.