By David Robinson, Next Avenue
Beset by headlines about stock market volatility, a spike in inflation and potential recession, Americans who are in or approaching retirement are understandably concerned about preserving their wealth.
Though it has waned in recent weeks, inflation is still higher than it’s been in decades, and most bond investors continue to suffer net losses as a result. And many individuals, shell-shocked by the stock market decline in the first half of this year, are reluctant to invest in equities.
Because of this, many investors are holding more cash, keeping it out of the markets. This poses a dilemma: While waiting to invest until they have more confidence, how can investors protect their cash from inflation? How can they keep their powder dry without losing too much of it?
Safe and Sane Savings Vehicles
There’s no magic bullet, but there are partial solutions. Some very low-risk savings vehicles pay interest rates that, while well below inflation, are far above the paltry 0.15% or so many financial services companies pay on uninvested cash held in brokerage and retirement accounts.
Various alternatives can ease the pain of inflation while allowing various levels of penalty-free access. That is important because penalties for early withdrawal can be so high that they defeat the purpose of having these accounts. The key is to strike the right balance between yield and access, in keeping with your goals.
The only way to beat inflation outright is to take a lot more risk than many investors want to take these days — by investing their cash in high-risk bonds or the stock market.
But for investors seeking to avoid market risk by not investing their cash for now, the idea is to reduce erosion by inflation as much as possible.
Here are a few partial solutions to consider:
I bonds. The “I” stands for inflation-linked because these federal government securities pay both a fixed rate that stays the same for the 30-year life of the bond and an inflation rate that is set twice a year. The combined annual interest rate (good through October) is 9.62% — above the current rate of inflation. Naturally, these bonds have grown in popularity as inflation has edged upward in recent months because they assure that holders get the full amount of the fixed rate — without the erosion of inflation.
I Bonds Are a Popular Option
Investors must buy I bonds directly from the U.S. Treasury. A distinct downside of these bonds is limited liquidity. I bonds cannot be cashed in for at least 12 months without a stiff penalty.
For individuals seeking to cash amounts well into five figures, this is an incremental solution at best because you can buy only $10,000 worth of I bonds per year. But if you know you won’t need the cash and, like some economists, you expect historically high inflation to persist for years, you could tentatively plan to buy the maximum amount each year and reconsider this strategy annually as market conditions change.
Higher Interest, Less Liquidity
Certificates of deposit (CDs). The top rates paid on 12-month CDs run from 2.75% to 3.00%. Three- and five-year CDs yields are much higher, but that’s a long time to wait for your money amid inflation. Tying up this money also prevents you from putting it back into the market, meaning you might miss out on a market rebound.
Though CDs lack flexibility, some investors use them precisely for this reason — as a self-disciplinary device to keep from spending money they’ve earmarked for particular uses down the road, with certainty that they won’t need it in the interim.
Online savings accounts. These accounts pay much lower interest than CDs — ranging from about 1.50% to more than 2.00% in most cases. But unlike CDs, these accounts tend to allow withdrawals any time without penalty and carry no market risk.
For convenient access to this cash, investors can set up a link from these accounts to their checking accounts to move cash back and forth online, using automated clearing house (ACH) transfers (not costly wire transfers), usually in a couple days. So keeping cash in online savings accounts affords generally the same ease of access as your brokerage accounts — but with far higher rates.
As Always, Read the Fine Print
A key caveat: Some banks advertise teaser rates that may seem great but, as the fine print states, shrink after you sign up. So, as always, be sure to read all disclosures.
Money market funds. Some funds offer yields comparable to rates paid on online savings accounts, but many don’t. Also, access might not be as quick (a few days) as investing at a bank, and there may be requirements for minimum balances and the number of withdrawals allowed. Before investing, it’s a good idea to compare expense ratios of different funds.
Recent market volatility has taught some investors that they have a lower risk tolerance than they once thought. They may find that keeping an appropriate amount of cash uninvested can ease their stress when markets are down or just murky. These investors can reduce stress even more by using these widely available tools to lessen the impact of inflation on this cash.