Preservation of capital is an important aspect of any financial plan, but in today’s economy, this is impossible without taking on some risk. At one time, you could confidently place any money you might need within one year in a high-yield savings account and be relatively confident that your money could buy at least as much a year in the future than it could buy the day you deposited your funds. Interest rates were relatively coordinated with the rate of inflation.
That’s not the case today. The Department of Labor released the latest inflation data. It should be no surprise to most consumers that the changes in the price of gas led to an increase in the energy index of 3.2 percent over the last twelve months (ending February). The inflation rate for all items is 2.9 percent. While the government-reported inflation rate doesn’t translate to the actual increase in expenses any one individual experiences year over year, it’s the best benchmark we currently have for a generalized view of the increase in prices.
And it’s the measure we use to determine how much purchasing power savers lose. If your savings account isn’t earning at least 2.9 percent after tax, you’re losing money in real terms by placing it in a bank. With banks offering less than 1 percent interest before taxes on their best high-yield savings accounts, purchasing power losses accelerate. Placing your cash under a mattress to earn zero interest is a worse idea, so are there any other options providing a safe way to maintain purchasing power?
Not really. Using a savings account is great for funds you might need in an emergency, because you can access the money quickly without worrying about selling an asset. Savers have to understand that having an emergency fund is a compromise; in return for the safety of an FDIC-insured account, savers waive the right to preserve real value, at least in today’s economy.
Any other options for preserving capital introduce risk.
- Investing in the stock market. Despite some recent frenzy about the stock market, with prices of the major indexes reaching near-term highs and day-over-day increases exceeding the best-performing day of the year thus far, there have also been daily price decreases reflecting the worst performance of the year. The stock market is incredibly volatile. For the long-term, it’s a good place to be, but there’s no guarantee that your capital will be preserved for when you need it.
Buying real estate. For years, families saw the house they live in as a way to store their wealth. The belief was unfortunately based on the myth that real estate values never decrease. Well, any asset can find itself in a bubble, whether they be tulips, stocks, or houses, and people who relied on real estate’s ever-increasing value to make a living have had a difficult time in recent years. It’s been terrible news for real estate flippers, but the effects hit single-house homeowners just as hard.
Although timing the market is always dangerous, with low prices and low interest rates, if you can qualify and if the time is right for your family, now could be the right time to buy a house, particularly if you’re looking to live there for a long time.
Buying Treasury Inflation-Protected Securities (TIPS). You can buy this investment product directly from the U.S. Treasury. Twice a year, you receive interest as well as an adjustment to your principal balance based on the inflation rate. This is basically a bond that will only lose value in the event of deflation. If you must sell TIPS after the value has dipped below your initial investment, you will still receive your full initial investment back.
There’s no risk in losing money, and this is the closest you might be able to get to true preservation of capital during inflation. Keep in mind, however, that the government’s reported inflation value doesn’t necessarily reflect any one household’s experienced rate of inflation. The government’s rate used for calculating TIPS adjustments, the CPI-U, uses the prices of a combination of goods that weights items in a way that might not be relevant to most consumers.
Buying gold. Investing in gold is traditionally a good way to hedge against inflation, but the price of gold fluctuates. Like all commodities, the value of gold at any particular time is subject to the whims of commodities traders. An investment in gold is not as stable as its reputation. The price fluctuation may be due to fluctuations in the value of the dollar or of any other fiat currency, but the cause is irrelevant because the U.S. dollar is the world’s standard for currency, and if that ever changes, it would be another currency or combination of currencies that becomes the standard, not a commodity like gold. The days of the gold standard are over.
Furthermore, most people who invest in gold use ETFs or mutual funds due to convenience. It would be inefficient and expensive to store and secure a significant amount of physical gold bars. Once you are dealing with electronic trades rather than a physical manifestation of metal, you’re subjecting yourself even more to the whim of the financial industry.
With low interest rates and increasing inflation, this may be a good time, from a financial perspective, to borrow money. You can do more with someone else’s money, repaying the loan with money valued less in the future. Borrowing money is of course not a good idea for people who could find themselves in trouble with debt, as interest costs could spiral out of control, but if you look at the numbers, borrowers are getting a much better deal, relatively speaking, than savers.
In today’s economy, if you are preserving your money, how are you doing so?
Photo: Lord Jim
Published or updated March 16, 2012.