Photo (cc) by earlycj5
Keeping your savings safe should be simple enough: after all, you just need to find an insured account at a bank, right?
Alas, life’s not so simple. Because while keeping your money in an insured account may protect your principal, you could still be risking your purchasing power.
For a quick illustration of how inflation can erode the purchasing power of your savings, check out this inflation calculator from the Bureau of Labor Statistics. What you’ll learn is that it takes nearly three times more today than in 1980 to buy the same stuff. So if you were earning just enough monthly from your savings to retire in 1980, you’re in hot water today.
What’s a saver to do? The answer is to earn more than the rate of inflation on your savings: something that’s easier said than done. Check out the following news story. I used the Goodyear blimp to talk about inflation not because it’s the perfect illustration, but because I wanted a free blimp ride.
Now that you’ve learned the lengths I’ll travel to get free blimp rides, let’s get back to the subject at hand: inflation and your savings.
If you’re serious about inflation, you should consider that, while the overall inflation rate as expressed by the CPI (Consumer Price Index) is a simple, single-number way to illustrate overall inflation, your personal inflation rate may be much different because the inflation you personally encounter depends on what you’re spending your money on. To see what I mean, check out this story called Inflation Predictions 2010.
But for now we’ll keep it simple by using the CPI. Currently US inflation as measured by the Consumer Price Index is around 2%. How much are you earning on your savings? In my money market account, I’m earning virtually nothing: .01%. So every day, I’m losing purchasing power: I’m going backwards.
That’s why I keep some money in other investments that will hopefully offset what I’m losing in my money market account. Here’s what I do, along with a bit more detail about the other things I mentioned in the above news story.
Over time, stocks have beaten overall inflation by a couple of percentage points. But the key phrase in that sentence was “over time.” During the first 10 years of this century, most widely known stock market indexes actually lost ground. So not only did the average stock lose purchasing power over the decade, it lost actual principal as well; not a pretty picture. Nonetheless, I’ve always kept some of my savings in stocks and always will. Why? Take a look at the stocks I own today. This is the model portfolio I built last year (with real money), and as I write this I’m up about 70% in one year, give or take. Is it unusual for me to be up 70% in a year? Exceedingly. In fact, it’s virtually unprecedented, so don’t think I’m suggesting that I normally make anything like that, or that you will if you follow my course. I’m merely pointing out that by spreading some savings into other types of investments, we can sometimes beat inflation, albiet not without risk.
I’m not going to spend any more time on stock investing in this post: books have been written on this alone (including mine, btw: Money Made Simple). But check back often because I’ll be writing more about stocks. In the meantime, here’s another recent story we did that might help, What to Know Before You Invest in Stocks.
Gold is often touted as a hedge against inflation, not to mention all kinds of other potential flies in the ointment, from political unrest to currency devaluation. Does it work? Well, pick your decade. In the 1970s? Yes. The 80s and 90s? Not in any way. The last decade? Most definitely. Gold entered this century at about $250/oz. and is trading today at more than $1,200/oz. That’s a nice return.
I certainly wouldn’t put a ton of money in this volatile metal… especially at these prices… but should inflation rear it’s ugly head in the near future, there’s reason to believe gold could easily go higher.
How do you buy gold? Well, if you take another look at my portfolio, you’ll note something called “SPDR Gold Shares”. What you’re looking at is an ETF (Exchange-Traded Mutual Fund) that owns gold bullion. So you can see that I put about 10% of my portfolio into gold, and did it by buying what’s essentially bullion in the form of a stock.
If you hate the idea of inflation but also hate the idea of stocks, Uncle Sam’s got just the thing for you. Two things, actually. The first is Series I Bonds, commonly called I-Bonds.
The “I” stands for Inflation, and these bonds’ claim to fame is the fact that they not only come with a fixed rate of interest, they serve up an inflation “kicker” that’s designed to insure that you stay ahead of inflation no matter how much it heats up. The bonds are issued every May and November. As I write this, the most recent batch (November 2009) were issued with an interest rate of .3% that stays the same for the life of this particular I-Bond. The inflation kicker, which adjusts every six months, adds another 1.53% (the inflation rate according to the Consumer Price Index for the preceding six-month period). So the total interest is .3% + 1.53%, or 1.83%. Not a great return, but one that’s, at least theoretically, beating inflation.
Read more about I-Bonds on the U.S. Department of the Treasury’s TreasuryDirect.
4. Treasury Inflation Protected Securities
The next type of US Government bond that’s tied to inflation is called TIPS, which stands for Treasury Inflation Protected Securities. This bond has some things in common with I-Bonds, but is different in others. For example, the interest on an I-Bond accumulates over its life and only pays you when the bond is redeemed. TIPS, on the other hand, pay interest twice yearly. Plus, if you use the earnings from an I-Bond for education, they can be tax-exempt: not so with TIPS.
In addition, the way TIPS work relative to inflation is also different than an I-Bond. With I-Bonds, as I explained above, the inflation “kicker” comes in the form of extra interest announced every May and September. With TIPS, the interest rate of the bond is fixed when you buy it: The principal is adjusted every six months with inflation.
Confused? If you’re not, you must not be paying attention. But check out a side-by-side comparison at the U.S. Department of the Treasury’s TreasuryDirect. It may help. Like many things that come courtesy of Uncle Sam, if you stare at them long enough, they often begin to make sense.
If stocks and gold seem too risky and government bonds seem like too much hassle, there’s still one thing left, but it’s easy to understand because you do it all the time. It’s called shopping. You can shop your savings rates like you do your gas or groceries. Actually, shopping your savings rates is easier than shopping for gas or groceries because you can do it in seconds online. One place is the site operated by my company: InterestMatters.com. But there are dozens more… most with the same information.
While shopping your rates won’t necessarily guarantee that you beat inflation, it’s a lot better than doing nothing. Example? At the beginning of this article, I said that my money market account was paying .01%, also known as nothing. But in less than 30 seconds, I go to the money market section of InterestMatters.com and find that I could be making 1.35%. Lousy interest? Yes, and it’s not beating inflation, but it’s 135 times what I’m making now, so it’s obviously a better choice.
Bottom line? Beating inflation is a worthy investment goal, and one every serious investor should strive for. Do some reading, think about your tolerance for risk and make some choices. Because while inflation is low now, odds are good it’s going to reemerge as a serious problem. Not today, but perhaps sooner than you think.