Now that I’ve explored inflation in-depth, and you hopefully have a good understanding of it, let's explore a few ways to protect your money from inflation. To begin, let's quickly recap why you may want to consider protecting your cash from inflation in the first place.
Inflation is a decline in the purchasing power of a currency over time. This means as time passes, you can buy fewer goods with $1. That's why a new Honda Civic was around $10,000 in 1990 but is $20,000 today. Similarly, inflation is why the average income rose from $12,513 in 1980 to $54,099 today.
You can see inflation in the form of a general rise in prices over time, so a loaf of bread increases from $2 to $3 over the span of many years. To adjust for this increase in prices, wages are increased, and because more dollars are required to buy the same amount of goods, the purchasing power of a dollar decreases.
This means that saving large amounts of money in cash can be harmful because the purchasing power of your money is decreasing over time. So, if you have $10,000 today, 30 years later, you’ll still have $10,000, you just won’t be able to buy as many things as you would have 30 years earlier.
Now, let’s discuss how to mitigate the effects of inflation.
If inflation is a consistent percentage decrease in the purchasing power of your money, it can be reasonably assumed that to battle its effects, you would need a consistent percentage increase in your money - you can’t change the purchasing power of your money, so you need to increase the amount you have.
How do you increase the amount without simply adding more money? The solution is to generate profit using your cash, through assets. When you purchase assets, you take on some risk, but if you consult a financial advisor and make a prudent decision, that risk will likely be minimized in the long term.
Assets provide profits in two ways, either through growth or through interest. Some assets, like stocks and real estate increase in price due to changes in demand (growth). Other assets, like bonds and certificates of deposit, provide regular interest payments to investors like me and you (interest). However, a third category exists, which includes a small number of assets specifically created by the US treasury to protect investors against inflation. This is what I’ll be discussing today.
The focus of this article is assets that are designed with the intent to combat inflation, so I’ll be focusing on inflation-protected assets, not assets that happen to provide returns and therefore mitigate the effects of inflation. In next week's article, I’ll be discussing other assets you can look into to combat inflation.
The first form of inflation-protect asset is the appropriately named Treasury Inflation-Protected Security or TIPS. TIPS, as the name implies, are specifically designed to protect investors' money from inflation. They do this by tracking the Consumer Price Index, which tracks the price of a group of goods that most people use/buy every day. Increases in the CPI indicate that the price of common goods is increasing, which is an indicator of inflation.
TIPS tracks the CPI, and adjusts the principal amount, and therefore, your investment, according to changes in the CPI. When inflation rises, the principal rises proportionately, and when deflation occurs, the principal falls proportionately. This means the real value (or inflation-adjusted value) of your investment will stay the same despite changes in inflation.
Furthermore, TIPS pay interest twice a year, at a predetermined fixed rate, with the rate applying to the principal, which is inflation-adjusted. This means the interest payments are also inflation-adjusted. Similarly, when TIPS mature, the payout is either the inflation-adjusted principal or the initial principal, whichever is greater.
If you want to read more about bonds, check out this article, and this link to read more about TIPS directly from the Treasury.
Series I bonds, also called I-bonds, are very similar to TIPS in that they also attempt to mitigate the impact of inflation by adjusting interest based on changes in the CPI. However, Series I bonds have to be purchased directly from the government, and cannot be purchased through a broker or bank, like other securities.
Series I bonds have two types of interest rates, one that is fixed throughout the term of the bond, and one that is adjusted twice a year based on inflation (a variable rate). Unlike TIPS, which have the principal change according to changes in inflation, Series I bonds have their variable interest rate change according to changes in inflation. So, while your principal doesn't change according to inflation, a portion of your interest rate does.
Other changes include a purchase limit on Series I bonds: you can only purchase $10,000 per year, and Series I bonds having a minimum 5-year holding period for a no-penalty sale (if sold before that 5 years, you will incur a penalty).
You can read more about Series I bonds here, and the differences between TIPS and Series I bonds here.
TIPS and Series I bonds are two great ways to protect your money from inflation while also enjoying periodic interest payments. Both TIPS and Series I bonds offer stability and intentional protection from inflation at the expense of an uncapped upside, unlike other assets. So, while both of these assets won’t triple your money over the course of years like other speculative investments might, they will provide inflation-adjusted returns and principal protection.
Remember, always consult a registered financial advisor before making investment decisions. With that said, I hope you found this article informative, please feel free to reach out with any questions, and I will catch you in the next one!