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Dear WalletFinance: How Should I Invest to Beat Inflation When Interest Rates Are So Low?

Oct. 2, 2012
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By Susan Lyon

Dear @WalletFinance:

I want my savings and investments to outpace inflation — or at very least to match it — but interest rates are so low right now that I don’t know what to do.  How should I be investing to maximize my return on investment?  Or should I just stash my cash under my mattress already?


Money Maker


Dear Money Maker,

Thanks for writing, and props to you for noticing that, indeed, interest rates are pretty terrible right now!  The fact that the Fed just announced a third round of quantitative easing (QE3) will keep them low for quite awhile longer, too.

Here’s the secret the big banks don’t always tell you: stashing your savings in a typical savings account just isn’t good enough anymore.  The short answer to your question?  No, don’t just hide your cash under your mattress. You’re better than that, and you know it.

The long answer?  You need to invest smarter than ever before, and here’s why:

  • As ATM and banking fees reach record highs and free checking accounts disappear off the map, it’s getting harder and harder to find a good checking or savings account that offers good bang for your buck.
  • Even if you’ve managed to snag a fee-free account, it probably isn’t offering much annual interest on your savings.
  • Interest rates are hovering at all time lows, and the third round of quantitative easing just announced by the Fed ensures that they’ll stay low for quite some time.
  • Along with this, inflation is expected to rise due to the increased liquidity in the market from QE3.

Higher fees, coupled with lower returns on my savings – and inflation to come?  That’s bad math.  So what’s a smart saver like you to do?  You’re much better off following one of the approaches below; you can do your research to beat inflation.

Inflation 101: Know Your Enemy To Defeat It

Inflation won’t hurt you, per se — it’ll just steal money from you if you allow it to.  It effectively makes each dollar in your pocket worth less.  To tackle inflation, you have to know when it’s on your side and when it isn’t.

Remember that candy bar that used to cost your grandpa just 10 cents when he was a kid?  It now costs $2 bucks in large part due to inflation; with the amount of money it will take you to buy one Snickers, he could have bought 20!  That said, the economy needs some amount of inflation to grow, and the Fed tries to keep it around a target rate of 2% that we are currently hovering below.  Just remember this:

  • Inflation is good for you if: if you are paying off student loans, buying a home, paying off loans, low interest rates are on your side since inflation will decrease the amount you owe in real terms (the 10 cents you owe used to be worth 1 candy bar, but now you only owe 1/20th of a candy bar);
  • Inflation is bad for you if: you’re trying to save and are getting lower returns on your savings than the current inflation rate.

 It’s definitely time to look beyond those low yield savings accounts of yesteryear, particularly those at big banks offering practically no competitive interest rates.  Whether it be finding new instruments to beat inflation, or trying your hand at investing in the stock market, the time is ripe to take advantage of financial instruments that you might not have considered a few years ago.

You’ve got to save smart to be smart.  Don’t worry, Money Maker, we’ve got your back.  Here are the big three financial instruments we like:

1. Go for TIPS and I-bonds to match inflation

If you’re a conservative saver – not a big risk taker – this one’s for you.  Neither tool will outpace inflation, but they will both match it.  And because the U.S. Treasury backs and guarantees them, you can never lose money from I-bonds even in the event of deflation.  You can buy both directly from the website.

These savings tools are set up specifically to match inflation, so you don’t have to worry about falling behind:

  • Series I U.S. Savings Bonds (I-bonds): These are ‘Series I U.S. savings bonds’ that are linked to the inflation rate, so that the payout interest rate is the combination of a permanent fixed rate combined with the inflation-indexed rate determined twice annually.  They can be purchased online or by using a portion of your tax refund via Form 8888.
  • Treasury Inflation-Protected Securities (TIPS): These are inflation-indexed bonds issued by the U.S. Treasury, the value of a TIPS fluctuates with inflation as calculated by the Consumer Price Index, and when the TIPS matures you are then paid out whichever is greater, its original or adjusted value.  They are offered in 5, 10, or 30-year maturities.  They can be purchased online for from some banks and brokers.

The Treasury offers a comparison chart of both tools, but our take is that both offer inflation protection and accomplish the same goal well.  They have a low correlation with other asset classes, which is what you want when diversifying a broader portfolio.

2. Buy Commodities to Try to Beat Inflation

Commodities – or basic goods and natural resources such as gold, oil, minerals, and agricultural products – are a smart investment buy in times of inflation.  Inflation causes the prices of commodities to rise, so you can benefit from investing in something physical when its widely recognized value moves up and down with inflation.  You can purchase commodities via a broker, an ETF, or a mutual fund.

Like investing in other financial instruments, be sure to diversify when picking what commodities or funds to invest in since inflation is not the only factor that affects their price.  An oversupplied commodity could decline in price even with high inflation.

3. Invest in Equities to Diversify Your Portfolio

From an investor’s perspective, the problem with any savings account is that low risk means low reward.  In this low interest rate economy, there are big limits to what you can get back.  These days, even the best rates are not very compelling, so if you want more for your money, consider investing it in a variety of mutual funds and stocks.  If you can handle higher risk, you stand to make more with your money, particularly if you have more time.  Word to the wise: stock market investments are risky so always keep several months of emergency funds on hand.

Want to stick with more traditional forms of saving?

If you want to stick with the basics, that’s fine too – just be sure to look beyond the big banks to find the best rates. Surprise: a lot of the best checking and savings accounts that beat inflation are offered by local credit unions!  A recent NerdWallet study found that credit unions offer higher rates than competing institutions; 80% of accounts identified with a rate greater than 1.70% were a credit union product, the highest percentage seen in the past three months.

So if you bank with one of the big guys, your first step is to check out the interest rate they’re actually giving you and then shop around.  Our September 2012 interest rate monitor helps identify some deposit accounts that beat inflation.

Don’t Kiss Your Money Goodbye

Moral to the story, you’d better be monitoring your savings account to make sure that it’s beating inflation – otherwise you might as well be hiding your cash under your mattress.

The super low interest rates we’ve been seeing for years now are definitely limiting our options; our current economic landscape means you have to be extra particular about where you put your money.  We hope this guide helps out so you can truly become a successful Money Maker – not just a Money Keeper!



Want to learn more?  Start by reading our inaugural investing 101 posts, A Framework For Investing and Asset Classes and Asset Allocation.