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If you've been noticing the price of nearly everything going up, you're not alone. The U.S. Bureau of Labor and Statistics recently reported that the 12-month change in CPI (consumer price index) has increased by a staggering 6.2 percent. With inflation that high, I’ve got a few strategies in mind to make sure that your nest egg doesn’t get eroded away.
In general, the best way to invest against inflation is to put money into assets that will produce higher returns than inflation. Ideally, these should be investments where the risks are minimal or at least matched to an acceptable level of comfort.
What kind of investments are we talking about? In this post, I'd like to explore a few options that I intend on using (as well as a few you’ll probably want to avoid).
Investments That Will Beat Inflation
While inflation may be high right now, it's important to put into perspective that this is the result of supply issues caused by the COVID pandemic. As things stabilize, so to will the price of all goods.
Typically, inflation is cyclical, and over the long term, it tends to increase by around 4 percent year over year. In fact, the Federal Reserve has a goal of trying to keep inflation to just 2 percent per year.
With that in mind, here are a few investments that will easily beat this 4 percent average figure.
Stock Market Index Funds
It doesn't take a financial wizard to know that most publicly traded companies earn way more than the rate of inflation. But stocks can also be incredibly risky. Invest in the wrong companies, and you'll end up losing a lot more than inflation will take away.
Thankfully, there's a solution for this: index funds. An index fund is a collection of securities that follows a major market index such as the S&P 500.
In a nutshell, all the index fund does is mirror the holdings contained within the index. By doing this, investors can easily diversify and capture the overall return of the broad market. This has classically been around 10 to 11 percent annually.
Even if we just focus on how the S&P 500 did during 2021, it's up around 27 percent (as of this writing). That's a full 21 percent net gain over the current rate of inflation.
REITs or Crowdfunded Real Estate
Real estate is another common way that many investors can achieve returns that soar beyond that of inflation. However, what if you’re not comfortable managing rental properties or flipping houses?
No problem! There are two easy ways you can reap the rewards of owning real estate without ever actually touching a single physical property.
The first is by owning a REIT or real estate investment trust. These are companies that are funded by the pooled money from thousands of investors (similar to a mutual fund).
With this capital, the REIT will buy a whole portfolio of properties, which are often large commercial buildings like offices, shopping malls, apartments, medical facilities, etc.
In return for their participation, investors are paid handsome dividends. Depending on the type of REIT and market conditions, it's fairly common to find REITs that have dividend yields in the 4 to 10 percent range. There are also REIT index funds (such as the Vanguard VGSLX) that further reduce your risk but pay lower dividend yields.
The second way to passively invest is through real estate crowdfunding.
This has many of the same benefits as REITs such as the opportunity to profit from large-scale commercial real estate and higher than usual dividend yields (sometimes in the double digits).
However, with crowdfunded real estate, you’re investing directly into the project and not into a company. This means your money may be tied up for years at a time making it illiquid. But, you also get more transparency about how your money is being invested as well as better chances for growth.
Interest on Cryptocurrency Accounts
One of the little-known benefits of investing in cryptocurrencies is that some of the platforms will pay you decent rates of interest on your holdings. For example, BlockFi pays Bitcoin and Ethereum investors a rate of 4.5 and 5 percent interest respectively.
Granted, most crypto is incredibly volatile making it an unfavorable option for most investors. However, there is an alternative solution: stablecoins.
A stablecoin is a crypto that is indexed to a fiat currency such as the US dollar. For example, the popular stablecoin Gemini Dollar (GUSD) has a price that remains stable at $1 at all times.
While that might not sound very exciting, now consider that BlockFi pays an interest rate of 9 percent to holders of GUSD. This means that for investing in an asset that should theoretically never change in value, you’ll make a net gain of around 5 percent above inflation. Not too bad!
For the better part of the century, investors have traditionally turned to gold as a way to hedge against inflation. However, given the speculative nature of gold’s value, this may or may not be a wise choice.
Always invest in multiple ways to ensure you can beat inflation.
Investments That Won't Protect Against Inflation
There are some classic ways that some people try to protect their savings against inflation. However, these methods have unfortunately become archaic and simply don’t work as well as they used to.
Here are a few of those strategies that you'll want to avoid.
If the bulk of your money is in a checking or savings account, then it's pretty safe to say that you're losing money.
This is just a comparison of interest rates. Since the national average payout on savings accounts is currently 0.06 percent, this means you've basically lost about 6.1 percent of purchasing power over the past year.
Even high-interest online savings accounts (which used to offer some of the best interest rates) are still not looking much better. With rates in the 0.5 percent range, that’s still well below inflation.
People have classically looked to bonds not only as a way to add stability to their portfolios but also to earn rates above inflation. However, with bond rates so low, most bond-based mutual funds and ETFs are falling short in performance.
Even bonds that are ear-marked against inflation, such as treasury I-bonds, are really doing nothing more than just keeping up with the rate of inflation. The treasury recently got investors excited with the announcement of a 7.12 percent rate for I-Bonds.
What most people don’t realize is that this is just the 6-month variable rate which is subject to change. Meanwhile, the fixed rate of I-bonds is 0.0 percent, meaning you’re effectively breaking even.
Invest to Hedge Against Inflation
Nothing can erode your nest egg and derail your retirement plans quite like periods of high inflation. So don’t let it! When it comes to investing, think bigger than savings accounts, bonds, and gold.
Instead, do your homework and check out what index funds, REITs, crowdfunded real estate, and interest from stablecoins could do for your portfolio.
The more you invest in assets that will be sure to produce long-term stable returns over time, the less you’ll have to worry about inflation.