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How Inflation Can Eat Up Your Savings -- and How to Avoid It

Posted
9/8/2013 2:30:00 PM
By: Motley Fool
Referenced Stocks:TIPS

As a hard-working person, you try your best to set a little money aside each month for savings. While putting a portion of your paycheck away to help prepare for retirement is responsible, that alone is not enough. It's important to be savvy with your investment strategy, because if you're not, inflation will eat up your savings.

No, inflation won't literally take money out of your savings account, but it will affect your purchasing power, making it difficult, if not impossible, to keep up with your standard of living. For example, if you've budgeted $65,000 per year to live on during retirement, you'll still have that same dollar amount of money -- but it will be worth less because of inflation. The $2.00 cup of coffee you bought this morning will cost you $4.00 in 20 years.

You need to keep up, so invest now.

Five ways to fight inflation with investment
Here's how investing can help you to deal with rising prices in the future:

  1. Become a bit of a risk-taker: While you certainly shouldn't fill your entire portfolio with high-risk investments, look for those offering an ambitious return. Receiving healthy interest payments can help to offset the rising costs of living brought on by inflation.
  2. Diversify your portfolio: This is classic investment advice for a reason. If you don't put all your eggs in one basket, so to speak, you won't take a huge hit if one stock or investment sector tanks. You won't need to be nearly as concerned about inflation if your portfolio is a mixed bag of investments designed to combat it.
  3. Treasury inflation-protected securities ( TIPS ): This type of government bond rises with inflation and falls with deflation. If you invest in TIPS, you'll receive payments of a fixed interest rate twice per year, which are adjusted for inflation. While it's great to receive a higher payment on years that interest rates rise, it's important to remember that your payments could decrease right along with deflation.
  4. Stay invested: If you think you need to cash in on your investments as soon as you retire, think again. If you stay invested, you'll continue to see a hearty rate of return and keep up with the rising cost of living. Of course, as you get older you should modify your portfolio to include more conservative stock choices, but don't give up on it.
  5. Shorter maturity bonds: Consider investing in shorter maturity bonds, as they typically aren't too affected by inflation. It is true that bonds of a longer term often carry higher interest rates, but they're also more vulnerable to inflation. Why? Bonds return at a fixed rate, and if the rate of inflation is higher than that rate, then your dollar isn't worth as much at maturity as it was when you purchased the bond.

Feeling overwhelmed by all this advice? Don't worry. Unless investments are your specialty, it's inevitable that you're going to be a little confused. Seek the guidance of a trained investment advisor who can help you choose the best portfolio to fit your needs. Remember, it's never too early or too late to start investing. Whether you're just getting started at your first full-time job or in a later stage of your career, learn how to create a strategy to deal with inflation that best fits your needs.

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