There is no denying that inflation has been surging. While we don't know how long it will last, we see that it is very damaging to our cash. There may be better places to park for those of you who have excess money sitting around to preserve your wealth and purchasing power. This article will cover the current inflation situation and look at some reasons why inflation may be transitory and why it may be longer-lasting. Then we'll talk about why inflation is bad for our wallets, and then we'll get into five places to park cash to combat inflation. We also covered this topic on our investing podcast called "Invest Smarter" if you prefer to listen.
The Current Inflation Situation
Inflation is currently running at 5.4% year over year, according to the latest Consumer Price Index (CPI) report. But that may be underselling the impact that inflation has had on Americans. We are paying about 55% more at the pump than we were last year. Beef prices are up more than 17%, pork is up more than 12%, fish & seafood is over 7%, and chicken is over 6%. Looked at buying a house lately? The typical home is up over 20% year over year. When we think about how long inflation might last, Unilever CFO Graeme Pitkethly recently said that he believes inflation will worsen in 2022 than in 2021.
Transitory or Structural?
One of the biggest debates on Wall Street is whether or not the inflation we have seen is transitory or not. The Federal Reserve Chairman, Jerome Powell, long maintained that the inflation we are witnessing is transitory and that it would go away as soon as supply chain disruptions resulting from COVID dissipated. He has since walked back that idea and now warns that inflation may be more persistent.
That has been the main argument for transitory inflation. Another factor that favors transitory inflation is the continued deflationary pressure of technological advancement, which increases the productivity of manufacturing processes, allowing prices to fall.
However, the economy is now faced with several factors that support continued inflation. One of these reasons is energy prices. Energy prices look set to stay elevated as energy companies slashed investment in new supply during COVID. While they are now trying to ramp back up, the new supply takes a long time to get absorbed into the market and reach the gas pump.
Another factor is the labor market. Right now, there are more open jobs than there are available workers. This has led to wages increasing. And if there's one type of inflation that is particularly sticky, it's wages. People are not going to readily accept lower salaries any time soon!
Another reason that inflation may stay elevated is the mountain of debt our government is in. Inflation can be good for those in debt, assuming that it comes with a corresponding rise in income. This is because our debt is a fixed amount, and if we are making more money, it becomes a smaller piece of the pie. If consumers are making more money, this is more tax revenue for the government to use to service the debt that is becoming a lighter burden. However, it's not like our politicians are showing much willingness to slow down spending, which by the way, is another factor that supports continued inflation.
Why Inflation is Bad for our Wallets
Inflation is bad for our cash. If you had $100,000 sitting in the bank over the last 12 months, it would only be worth $94,600 today in real terms. The 5.4% inflation we have seen can be considered a -5.4% return on your cash. If inflation stays at 5.4% for four more years, then your 100k would only be able to buy you about $75,000 worth of goods in today's dollars. That is why inflation is sometimes called the stealth tax.
Ways to Combat Inflation
Suppose you have excess cash beyond your emergency fund. In that case, it may be a good idea to consider parking it somewhere besides your savings account, which is paying you virtually zero in interest. Here are two better places to park your excess cash, depending on your risk tolerance and time horizon.
Series I Savings Bonds
Series I Savings Bonds, also known as I Bonds, are great because their sole purpose in life is to protect you from inflation. These bonds are issued by the government, which means that the interest and principal are as guaranteed as you can get. The interest is indexed to inflation and adjusts every six months. The term of a savings bond is 30 years, but you can redeem them at any time after year one. However, if you redeem before year five, you will forfeit three months of interest. The interest on these bonds is paid semiannually and is added to the principal of the bond. This means it is not a suitable investment for generating current income! You are only taxed when you redeem the bond, and they can be tax-free if used for qualified education expenses! With these bonds, your principal can never be reduced below the previous year's balance so that deflation won't hurt you. You can only buy $10,000 worth per year and can buy up to an additional $5,000 with your tax refund. This is a safe and very effective way to preserve your purchasing power of cash. You can buy I bonds on TreasuryDirect.com.
Treasury Inflation-Protected Securities (TIPS)
Treasury Inflation-Protected Securities are another option that protects investors from inflation. They differ from Savings Bonds in that they pay interest semiannually instead of adding the interest to the principal of a bond. The interest payments are taxable in the year you receive them. With TIPS, the principal can be reduced if there is deflation, so there is a risk of losing value, though it is still theoretically protecting your purchasing power. If you hold to maturity, you will receive either the original face value or the current principal, whichever is greater. In other words, if you hold to maturity, you cannot lose money on your principal. You can purchase a maximum of $5,000,000 worth per auction, so it is not nearly as restrictive as the savings bonds. You can buy these on TreasuryDirect.com.
Bottom Line
Inflation is punishing your cash. If you have a sufficient emergency fund, consider putting your excess cash somewhere that can protect you from inflation. Two government-issued bonds are designed to protect your purchasing power: I Bonds and TIPS. If you want to protect your wealth, talk to your advisor and determine if they make sense for you.
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