July 14, 2024
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In a nutshell

Today’s level of inflation (approximately 3.4% as of April 2024) is likely to have a strong impact on your savings and overall financial planning.

  • High inflation can lead to an erosion of buying power due to a surge in living expenses and increased borrowing costs.
  • To combat inflation, savers should keep cash in high-yield savings accounts, cut down on expenses and diversify their investments by considering options such as TIPS (Treasury Inflation Protected Securities), bonds and real estate.

Inflation and interest rates are a double-edged sword

The relationship between inflation and interest rates may not always be obvious, but there is a critical correlation. For the most part, when inflation is up interest rates follow, making it more expensive to borrow money.

This means that higher inflation reduces the real value of existing debt. However, as lenders demand greater returns to offset the loss of purchasing power, higher inflation leads to a rise in nominal interest rates.

During the COVID-19 pandemic, the Fed implemented monetary measures to mitigate economic decline. Some of these measures included boosting fiscal spending and lowering interest rates to historic lows for almost two years. This, coupled with stimulus payments and a decline in consumer spending, led to all-time high U.S. household savings.

Today’s heightened inflation has contributed to a lack of confidence and belt-tightening as consumers wait for interest rates to recover. That said, with lenders eager to boost deposits, consumers can now find competitive rates for high-yield savings accounts and a number of alternative investment options designed to safeguard savings.

How inflation impacts your savings

Inflation drives up the cost of groceries, gas, housing and bills in general. This impacts your savings in several ways:

  • Diminished purchasing power: Inflation reduces the value of money. If your earnings are not keeping up with inflation levels and your cash savings are not earning the sufficient interest necessary to outpace inflation levels, your money is losing value in real time.
  • Loss of value of long-term fixed investments: Investments with fixed payouts such as those for retirement and educational purposes may also be impacted by economic volatility and inflation. As prices go up, the value of these savings decreases.

How to measure the effect of inflation on your savings

There are a number of ways to measure the effect of inflation on your savings:

  • Track inflation levels. The Consumer Price Index is a widely used indicator for inflation. It tracks the changes in prices consumers pay for goods and services over time. If inflation is 10% in a year, and you have the same amount of savings at the beginning and end of the year, your savings have effectively lost 10% of their value.
  • Assess your real interest rate. You can subtract the current inflation rate from the nominal interest rate you earn on your savings to assess the true value adjusted for inflation. For example, if the inflation rate is 3% and your savings account earns 2%, your savings will face a loss of value by 1% annually.
  • Evaluate the impact of inflation on your investments. You can review your investment account performance to ensure that your investments are keeping up with inflation. To offset losses, shop around for the best high-yield savings accounts and certificates of deposit (CDs) offering rates outpacing inflation.

Where can you find inflation-beating interest rates?

To find inflation-beating interest rates, investors should consider investment options that yield higher returns than savings accounts. While these also carry their own level of risk, the following alternatives may help you to safeguard money during high rates of inflation:

  • Treasury Inflation Protected Securities (TIPs) are government-backed and available in five-, 10-, and 30-year terms. Their principal value and interest rates are adjusted for inflation.
  • Bonds. Similar to a Certificate of Deposit (CD), bonds are government-issued. While the money is locked in, rates are adjusted based on inflation.
  • Real estate. The value of property tends to increase during rising inflation. While mortgage rates also increase with rising interest rates, you may be able to refinance when rates go down, having gained significant equity along the way.
  • Gold and other metals. In the long term, the value of precious metals tends to keep up with inflation.

Related: How to invest in real estate

Saving vs. investing

The choice between saving and investing depends on your comfort level with the risk associated with each option.

Saving money carries a lower risk of losing significant value, and cash is immediately available. This can make a big difference if you face unforeseen circumstances such as loss of employment or a family emergency. In today’s high interest environment, there are a number of high-yield accounts that can help you make up for inflation rates.

Related: How to invest in a rising interest rate environment

Investing, on the other hand, typically comes with higher risk, but may offer more protective measures during business cycles.

Whether you are assessing different types of savings accounts, short-term investments or how to leverage longer-term investment options such as TIPs or bonds, ensure that you understand the impact of inflation on your future financial plans.

The AP Buyline roundup

When inflation is high, interest rates tend to rise. Because we do not know when interest rates will drop, there are a number of effective measures you can take to navigate today’s inflationary environment.

Most importantly, keep cash savings in a high-yield savings account. To cut costs, adhere to a budget that prioritizes paying off high-interest debt. If possible, boost your earnings through additional income streams. Consider diversifying your portfolio by investing in TIPs, bonds and other investments that tend to weather inflation well. Lastly, review your fixed investments to ensure that the impact of inflation on returns will not negatively affect your long-term financial goals.

Frequently asked questions (FAQs)

Are high interest rates good for savers?

Yes, high interest rates are generally good for savers. First, high interest rates and therefore high rates of inflation can help to slow spending. Second, when interest rates are high, banks are more likely to offer competitive APYs to boost deposits and thereby encourage consumers to save more. As of June 2024, the best high-yield savings accounts, for example, offer rates of up to 5.3%.

Is it worth keeping savings in cash?

It is worth keeping savings in cash. Leverage today’s competitive rates and high-yield savings accounts, and ensure that you have six to nine months in an emergency fund at your immediate disposal should an unforeseen situation arise.

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