Inflation and poor market performance are the biggest financial news stories of 2022. Many investors are now looking for ways to preserve the value of their savings against inflation. As a US-based investor, there are three main ways to protect against rising prices: Investing in equity-like securities, investing in I-bonds, or investing in TIPS. First, let’s clarify what inflation is.
Inflation refers to the increase in the price of goods and services over time. The most important measure of inflation in the United States is the Consumer Price Index. CPI is a measure of the price changes over time for a group of household goods and services. CPI data are released by the Bureau of Labor Statistics monthly. There are many factors that can cause it, such as economic growth, government spending, and supply and demand.
This can have both positive and negative effects on your economy.
Rising prices: The pros and cons
It can encourage economic growth through consumer spending and investment. Moreover, rising prices can reduce unemployment by making businesses more likely to create new jobs. Workers can expect to earn higher wages if prices rise.
Inflation can also reduce savings value and purchasing power. Inflation can also lead to higher interest rates which can discourage investment and slow down economic growth.
We now have a better understanding of the issues we face. How can we protect our portfolios from it? There are three main options for protecting your portfolio from inflation: stocks, I bonds, and TIPS securities. Each option comes with its own pros and cons.
Stocks are a great way to protect against inflation. Stocks tend to outperform other asset types during periods of high inflation. This is because companies can pass higher costs on to consumers, which results in higher profits. Stocks also offer capital gains that can offset inflation.
Stocks are more volatile than other asset types, so they can lose value even when prices remain stable. Using the Prillionaires personal finance software is a great way to keep track of all of your assets, like properties, cars, bank accounts, and most importantly, your stock portfolio, in one place.
I-bonds are a type of government bond specifically designed to protect against inflation. They are issued by the US Treasury and guaranteed by the US government. I-bonds offer both a fixed interest rate and a variable rate that is adjusted for inflation. I-bonds provide immediate protection from inflation by having this variable rate reset every six months.
Investors in I-bonds can only be partially locked in for five years. Investors who cash in I-bonds before the 5-year mark will lose three months of interest. Investors are locked in for the first year. In times of falling inflation, this can lead to investors being locked in for a lower yield.
TIPS securities are another type of government bond specifically designed to protect against inflation. They are issued by US Treasury and backed by full faith and credit by the US government. TIPS offers both a fixed interest rate and a variable rate that is calculated based on CPI. TIPS provides immediate protection from inflation because the variable rate is reset every six months. TIPS, unlike I-bonds, have a low yield, so they are not suitable for investors looking for income.
Is inflation a problem right now?
Rising prices are a major concern for investors right now. But I believe that part of the problem has been exaggerated. The Federal Reserve has begun to slow down the month-over-month price changes. The result is that prices are already on a normal course. The headlines report numbers that are year-over-year.
The headline number is therefore overstating the current inflation rate. Let’s take an example. Let’s assume that the CPI index was 100 in November 2021. In January 2022, there was an inflationary event that pushed the index to 110. The market recovered to normal, and the inflation index remained at 110 throughout 2022.
This scenario would see inflation disappear completely by November 2022. However, the year-over-year CPI print would remain at 10% through December 2022. This example shows the confusion that can result from comparing changes and levels.