The idea that you lose more money when you try to save it may seem like a ludicrous idea, but it’s actually happening in today’s financial markets.
This is because of a perfect storm – a mix of strong economic growth paired with high inflation and criminally low interest rates. The combination has essentially lowered how much you can earn on your money once you’ve considered inflation.
While there is a substantial amount in global savings, those who invest in assets considered “safe bets” are bound to get much less in purchasing power. Those brave enough to risk their money on less stable assets stand to get massive returns – but at the risk of losing it all if the market goes bust. The worst-case scenario for the risk-averse is seeing what little capital they have loset value over the years.
What can you do to save during a turbulent period?
In some cases, inflation surpassing interest rates is good, particularly if you borrow at a fixed rate and invest the money in assets like real estate or capital expenditures whose value will rise over time. However, if you save money for things like your children’s education, you may need to consider alternatives given the extremely low interest rate.
Such alternatives include Treasury bonds that mature in five years with an annual yield of approximately 0.77%; Treasury Inflation Protected Security (TIPS) bonds that may protect against high inflation at the cost of 2% in spending power per annum; or even corporate bonds.
Corporate bonds, however, carry a great deal of risk. It is highly possible that the company that issued your bonds could default. Also, these may only be enough to keep up with projected inflation rates. Indeed, some corporate bonds have yielded only 2.19%
Not a lot of options
Today’s inflation rates are comparatively low compared to the 1970s and 1980s when they hit double-digits. However, extremely low interest rates have created an environment where financial analysts and advisors are hard-pressed to tell their clients where to prudently put their money.
According to Rob Daly, director of fixed income at Glenmede Investment Management, it’s pretty hard to make an argument for fixed income. Consider this: those who buy bonds with very low yields will end up collecting a paltry sum in exchange for taking serious risks that may wipe out any gains they stand to earn.
In which case, allocating the bulk of one’s portfolio to cash assets is a surprisingly prudent thing to do. While it does pay no interest and savers will lose money in inflation-adjusted terms, one will always have money on hand to invest in longer-term investments when market conditions are more favorable.
Another option will be building a hybrid portfolio if you’re focused on medium-term investment. This is a portfolio that includes both cash and stocks that offer gains from corporate earnings.
Regardless of what you choose, however, one thing is clear: today’s rates do not seem to reflect the reality of the way we live.