If you’re not old enough to notice the gradual rise in prices over time, you’ve probably heard other people talk about it. People complain that their groceries cost more than ever before. Or maybe you’ve been told a dozen times what a penny could have bought you back in the day. This is inflation. But where does it come from? And how can you beat inflation?
The Gold Standard
Every once in a while, political or economic wonks like to start debating a return to the gold standard. If your eyes start glazing over, don’t worry, I won’t get too technical. Basically, a gold standard ties a currency to a specified amount of gold. The United States had a gold standard for a century until 1971, although even during that time the standard was not strictly kept. Under a gold standard, you would be guaranteed a certain amount of gold at any time for each dollar you held.
There are lots of arguments for and against the gold standard, which I’m not going to get into. But, if you’re interested, here’s one post on why the gold standard is so bad, and another one on why it’s the world’s worst economic idea. And here’s an article on why you should support a gold standard. And of course, Ron Paul had lots to say on the issue.
The long and short of it is that you can debate and debate until your ears are blue. For the most part, economists are against a return to the gold standard, but there are a few economists and a growing group of politicians that support the gold standard. So maybe we will see a return to gold, but for the time being, there’s no gold standard.
How This Affects Inflation
Since abandoning the gold standard, the federal reserve essentially controls the value of your dollar using a number of methods, including deciding how much money to print each year and where to set interest rates (not the interest rates you see at your bank, although these are related). Oh, and remember Trump’s comment about just printing more money to pay off the national debt? That wouldn’t be possible with a gold standard in place.
There’s a general consensus among economists that slight inflation is a good thing for the economy. The federal reserve generally aims for 2-3% inflation per year. With a gold standard, they wouldn’t be able to do this. So when you notice that your grocery spending is significantly higher today than it was 10 years ago, you can partly blame the departure from the gold standard. Although it’s probably just as much due to lifestyle inflation.
Either way, because of the gold standard, there’s no guarantee that your dollars will be worth the same from year to year. Thankfully, we haven’t seen any hyper-inflation in the US, so you don’t really need to worry about the dollars that you plan to spend within a year. However, there’s almost a certain guarantee that your dollar will buy much less 20 years from now. Basically any cash you have lying around is slowly eroding in value.
Fortunately, your only option isn’t just to buckle down and save twice as much. There are several ways to protect your long-term savings from inflation.
(Maybe) Keep Up With Inflation With Gold
The logical solution to not being on the gold standard is to just buy actual gold. If the US government won’t back your dollars with gold, just swap your dollars out for gold. However, although this strategy is logical in theory, it isn’t necessarily the smartest. For one, you’re essentially hoping that your dollars stay on par with inflation. You can do better. More importantly, because gold backed funds are so easily bought and sold on trading markets and exchanges, the value of gold fluctuates drastically and does a poor job at tracking inflation over any period shorter than centuries. When I said that you are essentially hoping to track inflation with a gold investment, you may have wanted to point out that ‘lots of people’ doubled or even tripled their money by investing in gold recently. Yup, they got in on the good end of a bubble. Lots more lost a significant amount of their money as that bubble burst.
Keep Up With Inflation With TIPS
If you do indeed want to merely protect your dollars from inflation and no more, investing in TIPS is a far safer way to do so. TIPS are Treasury Inflation Protected Securities. They are a type of US savings bond that pegs itself to inflation. As long as you still have full faith in the US Government, they are a guarantee that at least your hard-earned dollars will buy the same in 30 years as they would today.
Partially Protect Against Inflation With High Yield Savings Accounts
Although not a good solution for money you intend to hang on to for more than 5 years, a higher yielding savings account will at least partially protect you from inflation. In general, interest rates on savings accounts follow inflation rates fairly closely. Currently, interest rates are dismally low, but so is inflation (2016 was the first year in 5 years with inflation over 2%). In better years, you can find interest rates closer to 4%. Just know what to look for in a bank, so that fees don’t eat away at your rates. I personally recommend Ally Bank because of their fee free accounts, high rates, and good service, but I’m sure there are other banks that are just as good.
Beat Inflation With Bonds
Bonds are a good way to get a slight edge over inflation while still being a relatively safe investment. Bonds come in all shapes, colors, and sizes. They can have a lifespan of anywhere from a few days to decades. Bonds can be issued by the federal government, local and state governments, foreign governments and companies. In general, the more risky the bond and the longer the term, the higher the yield. So bonds issued by most foreign governments will give you higher yields than US savings bonds. Bonds issued by weaker companies will yield more than those issued by stronger companies. But these higher yielding bonds also run a higher risk of default, especially if the economy takes a downturn. In general, bonds also risk losing value if either inflation or interest rates suddenly surge.
You can purchase individual bonds through most brokerages, or you can buy US savings bonds directly from the treasury. I prefer to invest in mutual funds that hold a basket of bonds. Since I don’t have to consistently find new bonds to buy, I find this easier and more practical. I also then don’t have to pay a commission on each purchase. I personally recommend Vanguard because of their low costs.
Beat Inflation (Probably) With Stocks
If you have a while before you need your money, the stock market is one of the best places to both beat inflation and put your money to work. Although stocks fluctuate in value much more than bonds, stocks also outperform bonds over the long-term, giving you even more of an edge on inflation. When you buy stocks, you’re exchange your cash, which is slowly losing value, for shares of a company, which ideally continues to grow and create value. And regardless of what the bears say, you are not crazy for investing in the stock market.
Keep Up and Perhaps Beat Inflation With Property
At the bare minimum, property will keep up with inflation, simply by being an asset that will always be in demand. However, since property is limited in supply, but has a growing demand from an increasing population, property has the potential to become more valuable compared to other commodities. In other words, there’s good reason to believe that it will beat inflation. Additionally, property can yield a healthy passive income from rent while you hold it.
The most common way people invest in property is simply by buying a house. Most notably, this protects against rent inflation, while also allowing you to build up equity. Buying additional properties to rent out is also common. And if you’d rather not deal with the headaches of home ownership or landlord responsibilities, there are alternative ways to invest in property, such as REITs.
Hedging Inflation With Alternative Investments
There’s a whole world of alternative investments out there, ranging from art collection to bitcoin arbitrage to peer-to-peer lending. Some of these investments are more legit than others, so use your best judgement if you’re considering diving into these. Regardless of how legitimate a more niche investment is, simply being smaller makes it more prone to wild swings and bubbles as it rises and falls in popularity. So while niche investments might be a fun way to hedge some of your investing, I would strongly advise against putting the bulk of your money in these kinds of areas.
Picking a Mix That’s Right For You
Everybody has different goals, different time frames and different risk tolerances, so there’s no ‘right’ investment for everyone. Assess your own situation and pick what’s right for you. For cash that you’ll need in the very near term, access and stability is more important than hedging against inflation. For this, a savings account is probably the best way to go. However, as your time frame goes further out, bonds, property and stocks become better options, allowing you to not only keep up with inflation, but actually make a return on top of inflation.
Some links pay our bills. Our thoughts and opinions remain 100% objective. Find out more.
- While I do strive to only write accurate information and dispense valuable advice, I am not a licensed financial adviser. All information is based solely on my personal experience and personal research and should be treated as such. Find out more.