January 23, 2022
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Woman talks to friend about the best investments to beat inflation.

Woman talks to friend about the best investments to beat inflation.

In the simplest terms, inflation means that money loses purchasing power over time. You’ve probably noticed that things cost more now than when you were younger — as costs rise, the same amount of money buys less.

The rate of inflation varies from year to year and is determined by larger economic factors, including interest rates set by the Federal Reserve Bank (the Fed). In years of high inflation, prices for goods and services (e.g., groceries, gas, entertainment) could jump 5 percent. In other years, inflation could be less than 1 percent.

For financial planning, the average rate of inflation is assumed to be 2-3 percent. This means you’ll need to increase your income by at least 3 percent each year — keep this in mind when you’re asking for a raise — and find ways to save money that earn higher than 3 percent interest to maintain your current lifestyle.

Basic Savings Accounts Don’t Beat Inflation

A basic savings account is a great place to save money for easy access, but even the highest-earning savings account offers lower than 2 percent interest — and often less than 1 percent — which means your money is not beating inflation.

Everyone should aim to save three- to six-months’ worth of living expenses in a basic savings or money market account as an emergency fund, but in order to beat inflation, you’ll need higher-interest investments.

Certificate of Deposits (CDs)

With a certificate of deposit (CD), you agree to keep your money invested for a specific amount of time (usually from three months to five years) and earn a fixed interest rate. The longer you agree to loan your money, the higher interest you’ll earn.

Even the best CDs offer only around 3.25-percent returns and your money will be inaccessible for five years. If you withdraw before the term is up, you pay a penalty and miss out on the interest.

Finally, you must pay taxes on the interest earned from CDs. Deduct taxes when comparing investment options to determine if the returns on a CD are still beating inflation.

CD Laddering

Because you only get the inflation-beating interest rates when you agree to long terms, you risk missing out on higher returns that you might earn if your money were accessible. One strategy to get beyond this problem is called CD laddering, where you buy short-term CDs (12-month, 24-month), earn the returns quickly, and reinvest in longer-term and higher-return CDs. The laddering effect of investing in CDs with a variety of maturity dates allows more flexibility to move money.

But it also requires a lot of maintenance and, after taxes, you still might not beat inflation by much.

Retirement Funds

Man calculates that a basic savings account does not keep up with inflation.One of the most reliable ways to beat inflation is to invest in your 401(k) or similar retirement account at work, especially if your employer offers matching contributions. While nothing is guaranteed, the stock market historically returns 8 to 10 percent on investments over a span of 20 years of longer.

While values of individual stocks fluctuate and the market itself has highs and lows, when averaged over time, a well-diversified portfolio of long-term investments outperforms all other investments — and beats inflation. If you don’t have workplace account, you can open your own individual retirement account (IRA) or Roth IRA.

It might feel like a sacrifice to increase your 401(k) contributions, but it pays off in the long-term.

  • The more you put in, the more you get out. Increasing your 401(k) contribution by even 2 or 3 percent can mean thousands more in returns, which increases your chances of beating inflation.
  • The longer you invest, the bigger your returns. Time is your greatest ally. Because interest compounds over time, the longer it has to multiply, the bigger it will grow. Diversify and rebalance your portfolio once a year or so, but otherwise set it and forget it.
  • Matching contributions from your employer are free money. If you put in 3 percent and they put in another 3 percent, you’ve doubled your contribution without any effort.
  • Pretax contributions keep more of your dollars working for you rather than going toward taxes. (Although you will pay taxes on withdrawals.)

Diversify to Beat Inflation

One reason that retirement accounts are so useful in beating inflation is that they often are invested in a variety of mutual funds. Diversification protects against losses by spreading the risk out over many investments, categories, industries and financial products.

You don’t have to be an active investor to grow your money. On the contrary, the best returns often come from a minimally-managed portfolio. You have to be patient, but the slow investment in an IRA, Roth IRA, 401(k) or other retirement account is less risky and more profitable than any other way.

Other Ways to Beat Inflation

To really beat inflation, take a holistic view of your finances. Include saving as a regular part of your spending plan, contribute at least up to the matching contribution in your 401(k) and pay down debt. As you get closer to retirement, estimate how much more you could earn by waiting until age 70 to collect Social Security benefits. In some cases, working a few more years can mean 30 percent higher benefits.

Danny Smith