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.

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.

Bank Name: Your E-mail: Description (Please include URL):
We HATE spam as much as you, we don't sell your e-mail address!