Cash is liquid, simple, and feels secure. There are many good reasons to keep some cash on hand, from maintaining an emergency fund to being prepared for investment opportunities.
However, during times of higher inflation, cash in low-interest savings or checking accounts loses value quickly. The same lump sum of cash has less purchasing power each month. Fortunately, you can mitigate the cost of holding cash with these yield-bearing options.
Series I Savings Bonds
U.S. Treasury Series I bonds are designed to keep pace with inflation. If you purchase by November 2022, your initial rate of 9.62% is locked for six months. It then adjusts every six months based on inflation. The Treasury measures inflation based on the non-seasonally adjusted Consumer Price Index for consumer items, including food and energy.
Although the Treasury assesses inflation in May and November, any rate changes will apply in six-month increments after your actual purchase date. If inflation goes down or the economy experiences deflation, the yield on your I bond can go down. However, it will never go below zero.
One year is the minimum term to hold your I bond. However, if you cash in your bond before five years, you lose three months of interest. For example, if you hold for two years, you would earn 21 months of interest instead of 24.
Your uncashed I bond will continue to earn interest for up to 30 years. After 30 years, it will automatically be cashed out, and the earnings reported to the IRS.
Treasury Inflation-Protected Securities (TIPS)
TIPS are fixed-income securities that work like bonds. They pay a fixed interest rate, but changes in the Consumer Price Index adjust the principal. When inflation increases, so does the principal. As the value of the principal goes up, so does the amount of interest paid every six months.
The minimum maturity term for TIPS is five years. When they reach maturity, you receive the adjusted principal or the original principal, whichever is greater.
For medium-term investments, TIPS can be an inflation hedge to add to your portfolio. TIPS have the opportunity to outperform traditional government bonds when inflation is high because a traditional bond’s fixed interest payments will not keep pace with inflation.
Short-Term Corporate Bond Funds
Another way to mitigate the cost of holding cash during inflation is by buying short-term corporate bond funds. Major corporations issue corporate bonds to fund their investments.
They involve some risk but are generally considered safe because bond funds aggregate corporate bonds across various industries and company sizes. This diversification insulates you from poor-performing bonds.
Long-term bonds and bond funds don’t tend to perform well during rising inflation and interest rates, so short-term bond funds are historically a better choice in this environment.
Short-term bond funds pay interest at regular intervals, from monthly to semi-annually. There is no minimum term, and they are highly liquid. They can be bought and sold any day the financial markets are open.
Real Estate Investment Trusts (REITs)
REITs have a structure similar to a mutual fund. When you invest in a REIT, you are investing in companies that own and operate income-producing real estate. Property prices and rental income tend to rise when inflation rises.
A REIT can provide broad exposure to real estate, but they also have some drawbacks. Not every class of real estate fares well during inflation and rising interest rates. For example, office properties may experience higher vacancies while apartment buildings stay strong. Real estate markets are also highly local, which makes diversification important.
While REITs can deliver on returns, they are also sensitive to demand for other high-yield assets like Treasury securities. It’s also important to know that dividends earned on REITs are taxed as ordinary income.
Loans or Debt Obligations
Leveraged loans are another potential inflation hedge for the sophisticated investor. They are a floating-rate note, which is a variable interest rate debt instrument tied to a benchmark like the Treasury note or Fed funds rate. This means the return keeps pace with inflation.
Other similar options include:
- Mortgage-backed securities (MBS), which are structured pools of mortgages
- Collateralized debt obligations (CDOs), which are consumer loans
When you invest in loans or debt obligations, you do not own the debts themselves but invest in securities whose underlying assets are the loans.
These investment instruments can deliver a good return but are higher risk and can require a significant minimum investment. However, there are mutual funds and ETFs that specialize in these products and mitigate risk by investing in multiple loans or debt obligations.
Like real estate, some commodities rise in value during times of inflation. Commodities are a broad category that includes raw materials and agricultural products like grain, oil, copper, cotton, soybeans, beef, electricity, and orange juice.
In an inflationary environment, commodity prices tend to rise alongside the prices of finished products made from them. For example, higher grain prices elevate products made with grain, like pasta and bread, or higher crude oil prices are reflected in the cost of gas when you fill up your tank.
Commodities can be volatile. They are subject to fast-changing and unpredictable geopolitical forces, so they are not a good place to stash funds you need to be liquid, but for investors with the appropriate risk tolerance, they can be a way to hedge inflation with a portion of your portfolio.
Even if you are an experienced investor, you will probably benefit from the guidance of a CERTIFIED FINANCIAL PLANNER™ in the D.C. area when investing in commodities. At Brown Miller Wealth Management, our non-correlated alternative strategies include managed futures, private equity, and hedge fund strategies. We are happy to speak with you to determine if these options are a good fit for your portfolio.
Are CDs or High-Yield Savings Accounts Protected Against Inflation?
There are no CDs (certificates of deposit) or high-yield savings accounts offering enough interest payments to outpace inflation at current interest rates. They are a safe place to place some cash that you want to remain liquid, but the returns don’t sufficiently mitigate the cost of holding cash during rapid inflation.
If you choose to purchase CDs, a shorter-term commitment is better than a longer one. Your CD will stay at a fixed interest rate through its maturity date. As interest rates rise, you want to benefit from the increase, so shorter-term commitments allow you the opportunity to reevaluate your position regularly.
Put Your Cash to Work for You
Having liquid funds is essential for many reasons. This is particularly true for retirees who want to ensure they can cover near-term living expenses.
However, as a way to avoid market volatility during an inflationary period, holding cash is expensive. Not only may you owe capital gains on any positions you liquidate, but your money is also losing purchasing power as prices rise.
Fortunately, there are relatively liquid funds that are paying inflation-indexed returns. If you have any questions about the best investments for you, our experienced team of CERTIFIED FINANCIAL PLANNERs™ in the D.C. area is here to help. Contact us today!