Inflation and What It Means for Your Wallet (and Your Investments!)

“Inflation is as violent as a mugger, as frightening as an armed robber, and as deadly as a hitman.” This is what former U.S President Ronald Reagan had to say on inflation way back in 1978 when annual inflation broke 7.59%.

And while some may say his statement had a flair of politically-driven drama, experts are again sounding the alarm when it comes to inflation heading into 2022.

Inflation has surged to a 30-year high over the last year, leaving many Americans confused (and increasingly concerned) about how inflation may impact their savings and investments.

In this article, we’ll break down the key fundamentals of inflation, how it affects your wallet, and what you can do to hedge your bets (and your cash) against this costly phenomenon.

What is Inflation?

Inflation describes currency in a state of declining purchasing power, recognizable by an across-the-board increase in the average cost of goods and services.

Inflation averaged around 1.7% from 2010-2019, but in 2021 alone it has skyrocketed to 6.8%. That means if you stuck $100 in your sock drawer last November, the purchasing power of your stashed cash has decreased to roughly $93 just 12 months later.

Economists use a “basket of goods” - a fixed set of goods consumed by the average citizen - to compare month-to-month and year-to-year price changes to track inflation.

The resulting difference is used to generate a Consumer Price Index (CPI) ratio that represents the change in pricing and by extension, inflation. Currently, The Bureau of Labor Statistics (BLS) uses a list of around 80,000 goods and services to measure inflation and calculate CPIs.

How Does Inflation Affect My Savings?

Inflation can significantly impact the value of savings held in cash or low-APY bank accounts. Large cash-holdings will be affected by inflation exactly like $100 in your sock drawer, as the value and purchasing power of your cash assets is steadily lessened as prices rise.

Unfortunately, traditional savings accounts are also highly vulnerable to the effects of inflation. While savings accounts do typically accrue interest, the average rate applied to savings accounts serves as a marginal safeguard against declining purchasing power at best.

In 2021, a typical savings account would net you an average of around 0.06% APY. That means the impact of the year’s 6.8% inflation would only be softened to 6.74%.

In an account with $100,000 saved, this would represent a difference of $93,200 in purchasing power from cash stashed under your mattress (no judgments!) and $93,260 with an account earning the national average of 0.06% in annual interest.

As you can see, neither of these options are appealing to Americans seeking to grow their nest egg year-over-year.

How To Hedge Against Inflation with Investments

Interest is the enemy of inflation. By parking your savings in investments with a track record of yearly returns that outweigh inflation, you can maintain and even increase the future purchasing power of your hard-earned savings.

Investing in the Stock Market

A diversified stock portfolio provides a solid defense against rising inflation. S&P 500 returns with dividends reinvested have averaged an annual return of roughly 10% from June of 1930 to today. Even when taking inflation into account stock market investors enjoyed an average of 6% in annual returns over the same period.

If you’ve never invested in the stock market or are looking for the best funds and individual stocks to add to your portfolio to hedge against inflation, consider working with an experienced financial advisor.

Investing in U.S Bonds

Bonds are another option worth considering to hedge your savings against the draining effects of inflation.

While bonds provide more modest returns than stock market investments, their average interest over the last decade is around 5.48%, which is enough to hold off inflation and even conservatively grow your invested assets.

Some bonds are even designed specifically to safeguard against inflation. Treasury Inflation-Protected Security (also known as TIPS) automatically adjusts the value of your initial investment to align with annual CPIs.

As inflation continues to rise due to the wide-ranging impact on the global market caused by the novel coronavirus, experts are increasingly touting the benefits of TIPS and expect the popularity of this long-term investment to rise in coming years.

How Can I Learn More About Safeguarding Savings and Growing Investments?

If the last few years have taught us anything, it’s that it pays dividends to be prepared.

While millions of Americans suffered lay-offs and saw their savings dwindle as they struggled through the COVID-19 pandemic, their neighbors and colleagues with informed and diversified stock market investments saw their assets grow an astonishing 15.76-17.88%.

If you’re interested in learning how to create a nest egg that can weather (and even thrive) in a variety of economic and market circumstances, check out our knowledge and resource center.

And if you find yourself with more questions, or want to have a one-on-one discussion about inflation with a financial expert, reach out to us today.