How you can protect your retirement savings from inflation

You may not be worried about inflation today, but some economists are forecasting that rising prices may be a concern in the future. Inflation has been a hot topic lately because economic reports have improved. That, coupled with a government that looks to be spending more under the newly proposed tax bill, gives you the main ingredients for inflation.

A Federal Reserve study found that retirement was the most important motivation for Americans to save. At the same time, reaching a retirement savings goal is harder than ever. With this in mind, the time is at hand to evaluate how to protect your nest egg from inflation.

Inflation effects on retirement saving

As prices go up, your dollars buy you less. If you plan on living off a fixed income during retirement, inflation can make it harder to maintain your lifestyle. Inflation can also wipe out savings rather quickly. Not only will your retirement income buy you less goods and services, but if your investments are interest-rate sensitive they can lose value.

For the past couple of years inflation has remained under two percent. But historically the inflation rate has exceeded five percent in roughly one year out of every five since 1913. The odds are that you will see five percent or greater inflation before you retire. The question is which of your investments will lose value when rates go up?

A general rule is that as yields increase a full point, a bond investor loses a percentage point of principal for every year until their bond matures. For example, if you held $200,000 in 2-year Treasuries in your retirement account, a rise in the 2-year Treasury yield from 1.1 percent to 2.1 percent might drop the value of your Treasury securities to around $198,000 if you had to sell. The risk increases the longer your bond maturities extend out.

It is important to look at all your retirement holding including mutual funds, annuities and fixed-income securities to evaluate how they might fare if inflation picks up. It is much better to ask these questions today, instead of when hyper-inflation becomes a buzzword.

Hedging against inflation

The next step is to consider how to better protect your retirement savings from inflation. One way you can accomplish this is to reallocate your retirement portfolio to fewer interest-rate sensitive investments. A second way is to buy or own assets that gain value if inflation occurs. A few options include:

1. Investing in international stocks and bonds

Foreign stocks and bonds help protect your retirement savings if inflation skyrockets in the U.S. in relation to the rest of the world. It can be tricky to identify the countries in particular that will benefit if inflation hits the U.S., so owning a diversified fund that invests in both developed and emerging markets is a good idea.

2. Buying TIPS

The acronym TIPS stands for Treasury Inflation-Protection Securities. The Treasury Department issue TIPS with a fixed coupon rate that is lower than rates on corresponding Treasury bonds. The principal of a TIPS is adjusted as inflation, measured by the Consumer Price Index, increases. The higher inflation goes, the more valuable your TIPS investment becomes. Mutual funds that specialize in TIPS offer investors a way to have fund managers look for underpriced TIPS, but can also be more volatile than holding TIPS directly.

3. Owning energy stocks

In an inflationary economy, two commodities that invariably rise in value are oil and gas. This is good news for stocks that derive profits from oil and gas prices. If you are an investor with a portion of your retirement savings in stocks and mutual funds, check your holdings to see if your portfolio will benefit from rising energy prices.

4. Purchase indexed CDs

Keeping money in laddered CDs can help you take advantage of rising savings rates. You can also find banks that offer variable-rate CDs with rates that are reset higher as a benchmark rate goes up. Look for banks to start offering more inflation-indexed CDs if inflation really starts to pick up.

5. Holding commodities

Investing in commodities to combat inflation is a time tested strategy. Simply said, as prices increase you want to own the assets or companies that benefit. Look for a mutual fund to help diversify your money across different commodities, instead of focusing on just one commodity like gold, copper or silver.

Tapping retirement investments: 4 tips to avoid running out of money

by Barbara Marquand

Most baby boomers fear outliving their retirement savings more than they fear death, according to a survey conducted this year for Allianz Life Insurance Company of North America.

Of course knowing how much to save and accumulating enough of a nest egg are critical, but just as important is managing withdrawals of retirement assets so investments last a lifetime.

Here are five tips:

1. Plan a reasonable withdrawal rate.

Assuming you have 50 percent to 75 percent of your portfolio in stock, research studies show a safe annual withdrawal rate of assets is between 4 percent and 5 percent, annually adjusted for inflation, according to the National Endowment for Financial Education. (That would be $40,000 to $50,000 a year for a $1 million portfolio.) What if you're more conservative? Withdraw a smaller percentage if you have a larger share of your portfolio in conservative investments, such as bonds.

Financial experts recommend setting up a regular pay schedule for taking withdrawals. Once you've determined the percentage and annual amount of income, decide how you'd like to receive your pay -- monthly, weekly or biweekly. Then divide the annual income. For instance, if you take 5 percent a year on a $1 million portfolio, you'd get $50,000 year, $4,167 a month, $1,923 biweekly or $962 a week.

2. Maximize tax savings on withdrawals from investments.

Draw first from taxable investments -- accounts other than 401(k)s and IRAs -- to give tax-deferred investments more time to grow. Long-term capital gains on these investments are taxed at a lower rate than withdrawals from tax-deferred accounts, which are taxed as ordinary income. Another option for early retirement withdrawals is from tax-free investments, such as municipal bonds.

Delay taking withdrawals from tax-deferred accounts as long as you can until age 70 1/2 when you must make minimum withdrawals to avoid tax penalties. If you have to take money out before then, draw first from tax-deferred accounts made with after-tax dollars, such as annuities. Unlike a 401(k) or traditional IRA, Roth IRAs have no minimum withdrawal requirement at any age, so save withdrawals from a Roth for as long as you can.

3. Keep some assets in a money market account.

It's a good idea to keep a few years worth of withdrawals liquid, such as in a money market account or a high interest savings account. That way you're not forced to sell stocks in a bear market or sell bonds when prices are falling to get money for living expenses. You can also build a CD ladder -- a series of CDs with staggered maturity dates -- to provide steady access to income. Search online for the the best CD, savings account and money market account rates to make your money work for you.

4. Consider annuities.

The National Endowment for Financial Education says to consider investing part of your retirement portfolio in annuities to provide a steady stream of income. Annuities are sold by life insurance companies and guarantee a certain rate of return for a certain period of time or for the rest of your life. Fixed annuities are less risky and more straightforward than variable annuities, but variable annuities offer the potential for greater return. Make sure you take fees into account and understand how an annuity works before you invest.

Talk to a trusted financial advisor and make a game plan for how you'll handle your assets in retirement well before it's time to quit working.

5 interesting places to park cash

Americans are starting to save more money and spend less. The personal savings rate in U.S. has increased up to 5.7 percent according to data from the Bureau of Economic Analysis. It was only a few years ago, back in October of 2007, that the personal savings rate was as low as 1.7 percent.

Saving for a rainy day is always a great idea, but now the question is where to keep your hard earned cash?

There is no doubt that keeping your money in a bank savings account is a safe and time-tested option. Savings accounts are definately better than hiding money under the mattress. The problem is inflation can eat away the purchasing power of your savings. You want safety first, but you also need to make money. Here are a few different ideas for parking your cash.

1. Reward debit cards

If you pay for your monthly purchases with a debit card instead of a credit card, your money is immediately deducted from your checking account or preloaded card. This might sound like a bad deal, but if you use a debit card that offers rewards you can actually save money.

The amount of extra money you earn in your checking account waiting to pay your monthly credit card bill is miniscule, when compared to the cash back and merchant discounts you can receive from using a reward debit card. Consider buying a pre-loaded debit card with significant perks or stashing money in a checking account that has a reward debit card linked to it. Not all banks offer reward debit cards, so you may need to shop around to find the best deal.

2. Global bond funds

In the recent past, short-term U.S. government bond funds were a no-brainer when it came time to name places to park cash. Not anymore. Now you have to factor in what will happen to the price of government bond funds if interest rates shoot higher.

An alternative option is investing in a global bond fund with a short duration. Investing in a global bond fund diversifies your risk by investing in bonds from different countries. Fund managers can move money strategically to the countries with stronger economies and currencies. Many global bond funds still keep a percentage of assets in U.S. Treasury bills.

3. Discounted gift cards

If you play your cards right, loading up on a few gift cards can be a great savings idea. Retailers like Sam's Club, Best Buy and Walmart will sometimes offer discounts on their cards directly from their website or other promotions. The key is to only buy what you need and to search for the deeply discounted cards.

The advantage of buying gift cards with your extra savings is that you can often save more money from your favorite retailers, than the amount of interest you earn from parking your money in CDs, money market accounts or savings accounts. Just remember to avoid gift cards that have extra fees associated with them or that may sit unused on your desk.

4. I-Bonds

Inflation-indexed savings bonds offer investors an easy way to protect their savings from inflation. Individual investors can buy I-bonds online from the Treasury Department for as little as $25. I-bonds pay an interest rate comprised of a base rate and semiannual inflation adjustments. Attractive features of I-bonds include that investors pay no commissions, the bonds are exempt from state and local taxes and federal taxes can be deferred. The value of an I-bond does not fluctuate in value like a TIPS fund or a short-term bond fund, but you must keep it 5 years before you can redeem it without a penalty.

5. Reward checking accounts

The best checking account rates are paid what are called "reward checking" accounts. This type of checking account pays a premium rate on balances up to preset amount, as long as you meet monthly requirements. The specific criteria to earn the best rates can vary from bank to bank, but will typically include receiving electronic statements, making debit card transactions and paying a bill online.

The higher rates and online banking features make reward checking accounts a great place to park cash. Even the rates you earn for your balance over the preset limit are typically higher than passbook checking account rates.

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Disclaimer:This content is not provided or commissioned by American Express. Opinions expressed here are author's alone, not those of American Express, and have not been reviewed, approved or otherwise endorsed by American Express. This site may be compensated through American Express Affiliate Program.

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