Inflation is a tricky force that affects the value of your earnings and makes investing more challenging.
While economic experts expect an average amount of annual inflation, usually between 2% and 3%, the past few years have seen higher-than-usual amounts. For instance, the inflation rate averaged 4.7% in 2021, a near record high of over 8% in 2022 and 4.1% in 2023.
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GOBankingRates spoke with Christopher Stroup, a CFP with Abacus Wealth Partners, to explain how you can invest to hedge against inflation — in other words, so you still earn money and keep the value of your income.
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The Silent Financial Deterrent
Stroup called inflation “that silent deterrent that can really throw your financial situation off the rails if you’re not cognizant of it.”
He said inflation is all about purchasing power. “You used to be able to buy a gallon of milk for maybe $2 several years ago, and now it’s maybe costing you $4. And so that’s what we talk about in terms of what you’re able to buy goes down as a result of inflation in terms of what you could get per dollar that you spend,” he explained.
Understanding this concept is “key for people to understand,” Stroup said, so that they can build a stable financial future.
The goal of saving and investing is to outpace inflation, Stroup said, “so that you can ensure that you can continue to purchase and lead a lifestyle that you want in the future depending on what you want that to look like.”
Beating inflation, thus, takes some careful planning.
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Look At Your Cash
Stroup recommended starting with what he called the “lowest-hanging fruit,” which is looking at your cash-money that might not immediately be going to expenses.
“What are you doing with that cash? Because that is the first area where things could go wrong. If you’re just sitting on cash in a checking account, earning nothing on it, inflation is going to eat into that,” he explained.
He advised putting your cash to work so that it can out-earn the rate of inflation. For example, if you put your savings into a high-yield savings account that pays 4% interest, then you’re outpacing inflation at 3%. After you account for the higher costs of living, you’re still earning something on top of that.
“At minimum, we want to at least keep up with inflation, especially with our cash. And so look at those immediate resources and ask how could they be allocated? So is it a high-yield savings account? Could it be CDs for cash that is set aside for an emergency or maybe a future home or something like that?” Stroup said.
Consider Time-Based Investments
As Stroup noted, you could also put your money into a certificate of deposit (CD) for a higher yield on your money. However, you do need to know that your money will be essentially locked up for a set time period, be that six months or a year.
“But that’s a trade-off that if you don’t need the money necessarily in the near term. You could trade off liquidity for a higher yield,” he said.
It’s important to understand the pros and cons of each of those decisions and what you’re willing to take on in terms of your finances.
“CDs, bonds, treasuries, things like that all have a place in terms of helping you earn at inflation or a little bit above inflation while being in assets that are considered safer for you in terms of a risk tolerance scale,” Stroup said.
Always Create an Emergency Fund
Your investment strategy will change depending on how much money you have to put away, Stroup said, but the first step is typically to create an emergency fund.
“Typically we advise [saving] anywhere from three to six months, maybe even a year’s worth of expenses depending on your situation and depending on how much peace of mind you want to be able to sleep with at night,” he said.
An emergency fund should maintain a certain amount of liquidity, according to Stroup. “So that may be more preferential to put in a high-yield savings account,” he said.
If you have additional funds, Stroup said you might consider putting them into a CD that has a longer duration, because you can give up that liquidity.
“I think about it more of making sure your immediate sort of buffer zones of safety are taken care of, and then as you fill buckets, you can take on a little more risk. That risk could be a lack of liquidity or moving into investment accounts and things like that to ultimately sort of orient that money towards long-term growth,” he said.
The Best Inflation-Beating Investing Vehicle
While the methods mentioned so far are good at beating inflation, the best way to beat inflation is by participating in the stock market over long periods of time, Stroup said.
“The stock market has been a surefire way to outpace inflation. Now that comes with near-term volatility and … nobody knows what the market’s going to do from day to day,” he warned. “However, over longer time horizons, like five to seven-plus years, if you stick to a strategy, you’re more often going to be able to outpace inflation by a decent amount.”
For example, he said, the S&P 500 has averaged about an 11% return over the past several decades, about an 8-percentage-point gain over average inflation year over year.
“Depending on your risk appetite and your investment time horizon and some other factors, that might be a great strategy for you to ensure that you’re doing what you can to outpace inflation or hedge against inflation,” he said.
For the average person, participating in the stock market through a combination of retirement accounts, like IRAs and 401(k)s, as well as a brokerage account can really keep you ahead of inflation and help you build a healthy financial future.
Real Estate Is a Solid Move
Lastly, Stroup said that many people invest in real estate to help outpace inflation, whether with their primary home, rental properties or real estate investments in their portfolio.
“That’s why REITs (real estate investment trusts) exist. So even if you don’t necessarily own a rental property or a home, you could still participate in that area of the market with those kinds of investment vehicles,” Stroup explained
He said these are often great tools to outpace inflation over long periods of time because increases in inflation often get passed along to the renter, which means higher revenue for those landlords.
Take a Diverse Approach
For people with more significant excess funds, Stroup recommended investing in the stock market, but ideally through a long-term investment strategy that takes into account your risk allocation of equities as compared with fixed assets.
Ultimately, the best strategy is a diverse one, not ever leaving your money all in one place and adjusting investments as needed.
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This article originally appeared on GOBankingRates.com: I’m a Financial Advisor: 5 Genius Ways To Invest Against High Inflation
