Taxes

How to Protect Your Money During Inflation

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High inflation got your stress levels up? Here are some savings and investment strategies you can use as an inflation hedge to protect your money’s value as prices soar.

Inflation calculator

What is inflation?

As many of us have experienced firsthand during the pandemic, the rate of inflation is highly dependent upon current events and how they affect the global economy.

Inflation is defined as an increase in prices and a fall in the purchasing power of money. It’s linked to supply and demand — as consumer demand rises, the price of goods and services goes up. Demand can increase when the supply chain is limited, or consumers have more money to spend (perhaps due to rising wages).

The Federal Reserve closely tracks the measure of inflation year-over-year. As of May 2022, the inflation rate increased by 6.3 percent from May 2021. To help combat inflation, the Fed often hikes interest rates, making borrowing more expensive for consumers and helping curb demand.

Short-term saving strategies during high inflation

So, how can you protect your money during inflation while retaining the buying power of your savings as best you can? Here are some tips for you to consider in the short term.

1. Stick to a budget.

It may seem obvious, but controlling your spending should be goal number one. Start to look at where your money has been going every month to get a good idea of how inflation impacts your spending habits and where you can make some adjustments.

Pro tip: Another good idea is to budget for longer-term savings in the form of investments, which we cover in the next section.

2. Shift your buying habits.

Inflation often affects some merchandise more than others. For instance, in 2022, products such as gas and animal-derived groceries like meat, eggs, and cheese have seen some of the highest price increases.

Because of this, you might want to alter your regular budget to accommodate specific price hikes. If you’re someone who normally buys name brands, try going for a generic option instead. If your family eats a lot of animal products, you could consider buying less expensive, plant-based options. If fuel costs severely impact your budget, see if you can cut back spending in other areas (some monthly subscriptions, perhaps) and reallocate those funds to other areas.

Pro tip: Divide your budget into two categories: wants and needs. Try cutting back on as many wants as possible and reevaluate your budget often to find more potential saving opportunities.

3. Build an emergency fund.

Financial planning experts often recommend having a liquid emergency fund totaling three to six months’ worth of necessary living expenses (housing, food, bills, etc.) in case you become unemployed or face another emergency.

How much you choose to save depends on your unique family and financial situation. Do you work in a high-risk industry that could experience layoffs during an economic recession? Are you self-employed or retired with a less steady or fixed income? Ask yourself similar hypotheticals to help you plan how much to save in case of unemployment in the future.

Pro tip: Consider putting your short-term savings, like your emergency fund, in a high-yield savings account with higher interest rates where your money will have better earning potential to help combat rising inflation.

Long-term savings and investment strategies

Investing is often a better long-term option than saving during high inflationary periods. A diversified portfolio is recommended by economists, but your chosen strategies should depend on your risk tolerance and personal finance goals.

Here are some possibilities to consider:

1. TIPS and Series I savings bonds

Treasury inflation-protected securities (TIPS) are a type of U.S. Treasury bond with a fixed rate paid out twice per year. TIPS are different from other types of bonds in that their principal amount changes based on the Consumer Price Index. This means the bond’s face value goes up or down to keep pace with inflation.

Don’t worry, though — you’ll never lose money in the event of deflation. Even if the bond’s face value at maturity is less than what you paid for it, you’ll still get back the amount you originally paid.

The principal growth and any interest income earned from TIPS are subject to federal income tax but exempt from state taxation. Note that any increase in your TIPS value is taxed as income in the year you received it, not the year the bond matures.

Series I savings bonds (I bonds) are another bond backed by the U.S. Treasury designed to be protected from inflation. These low-risk savings bonds pay interest through a combination of a fixed rate, and an inflation rate determined every six months. I bonds mature after 30 years, but you can cash out as early as one year (though cashing out your I bond before five years of ownership means you will forfeit any interest earned in the previous three months).

Interest earnings from I bonds are subject to federal income tax but exempt from any state taxation. You have the option to either report your interest earnings every year or put off reporting any interest until you cash out the bond or it reaches maturity.

Pro tip: Want to invest in bonds but not sure which type of bond to choose? The U.S. Treasury has a handy comparison chart showing the differences between TIPS and I bonds to help you determine which is right for you.

2. Real estate

As inflation rises, property and rental prices tend to rise with it. Because of this, you could choose to put your money in real estate by either renting out a property or, if you’d rather not buy or manage the property yourself, you could invest in real estate investment trusts (REITs). REITs are companies that own income-producing real estate. When you invest as a shareholder in these companies, you earn income through dividends.

Pro tip: Any dividend payments you receive as a REIT investor can be taxed differently depending on if the payments are constituted as ordinary income, capital gains, or a return on capital. As a shareholder, you’ll receive a 1099-DIV from the REIT explaining how your dividend payments are classified.

3. Gold

Investing your money in precious metals like gold is another possible strategy for keeping up with inflation. Gold has long been considered a safe investment by investors and a potential hedge against inflation.

But like any other investment, investing in gold has its pros and cons. You won’t get dividend or interest payments from putting your money in a tangible asset like gold, though gold tends to hold its value even as market prices shift and stock prices go down. In an inflationary environment and times of geopolitical uncertainty, gold often increases in value, but there is obviously no guarantee.

Ultimately, choosing to invest in something like gold depends on your personal risk preferences and the period you’re planning on holding the gold.

Pro tip: Did you know you can also buy gold using an IRA?

3. Stocks

Stocks are considered a good thing to have in your long-term investment portfolio, though inflation can cause them to take a hit in the short term.

Though stocks can have high volatility, putting your long-term savings in the stock market is generally a good way to beat inflation. When inflation hits, try to rebalance your stock portfolio by investing your money in industries poised to do well during an inflationary period (such as food, energy, or other staples people need, even during periods of economic uncertainty).

Pro tip: The average annual return of the S&P 500 Index is approximately 10.7 percent — still higher than the current inflation rate of 6.3 percent in mid-2022.

Calculations based on the Consumer Price Index.
This article is for informational purposes only and not legal or financial advice.

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