4 Foolproof Ways to Protect Your Money From Inflation

By Damian Davila on 2 September 2016 0 comments

Back in January 1980, when Jimmy Carter was President and Michael Jackson led the music charts with "Rock with You," Americans were experiencing one of the periods of highest inflation in modern history. In January 1980, inflation was over 13.9% per year and peaked in April 1980 at 14.76%.

With the consumer price index (CPI) at 0.8% in July 2016, many Americans have never experienced the dramatic increase in prices that other generations have. But even though inflation is low these days, it still eats away at your savings and investments. Let's review four (nearly) foolproof strategies and investments that will reduce the hit.

1. Invest in an S&P 500 Index Fund

The average annual inflation rate since the U.S. government began tracking it in 1913 is about 3%. To combat inflation's effect on your money, you need investments that provide greater average returns than the inflation rate.

Since its inception in 1928, the S&P 500 has provided an average annual return of 11.25% until 2015, making this stock market index a leading choice to protect yourself from inflation. For the greatest ease and cost-efficiency, invest in a mutual fund or exchange-traded fund that mirrors the S&P 500's performance.

Not only are the average returns of passively-managed S&P 500 index funds higher than those of actively managed funds, but also the expense ratios of S&P 500 index funds are lower than those of actively managed funds. For example, the Vanguard 500 Index Investor Shares fund [Nasdaq: VFINX] has an annual expense ratio of 0.16%, which is 84% lower than the average expense ratio of funds with similar holdings.

Of course, this approach isn't actually foolproof, since both the rate of inflation and market returns vary from year to year. But when considering long-term averages, it's a fairly safe bet.

2. Increase Annual Contributions to Saving Accounts

Even when you leverage high-yield online savings accounts, you'll only make between 0.75% and 1.05% per year, according to data from August 2016. With a July 2016 CPI of 0.8%, you're actually losing 0.05% and gaining only 0.25% per year. (See also: Capital One 360: A Competitive Banking Option)

Setting up automatic transfers from your paycheck or main checking account to your investment and saving accounts is a smart idea, but adjusting those contributions for inflation is an even better one. A good practice is to make an adjustment for inflation once a year. Check with your financial institution to find out if it offers the option of automatic adjustments for inflation to your contributions.

3. Seek Real Estate Income

While gold has a great reputation as an investment hedge against inflation, real estate income has proved to be a better hedge tool. A study from financial company Fidelity back-tested the performance of several assets against inflation on an annual basis during a 40-year period and found that gold and real estate income beat inflation 54% and 71% of the time, respectively. "Real estate is regarded consistently as a good inflation hedge, and it is", asserts Susan Wachter, professor at the University of Pennsylvania Wharton School of Business. (See also: 4 Reasons Millennials Should Invest in a Home)

While most individual investors can only afford to buy their own home, all individual investors can gain exposure to real estate income from a wide variety of properties through real estate investment trusts (REITS). Some advantages of REITs are their requirement to maintain a dividend payout ratio of at least 90% and their liquidity because they trade on major stock exchanges.

For example, the 10-year annual average return of the Vanguard REIT Index Fund Investor Shares [Nasdaq: VGSIX] is 7.46%, as of June 30, 2016. In comparison, the 10-year annual average return of the S&P 500 was 7.42% for the same period.

Adding REITs provides you access to assets with inflation resistance and helps you protect against the negative of higher inflation. Still, REITs should only be a part of a well-diversified portfolio. Depending on your tolerance to risk, financial advisers suggest allocating from 5% up to 20% of your investment in portfolio in REITs. And of course, past performance is no guarantee of future success.

4. Negotiate Your Salary

If your salary were to consistently go up every year, you would not to worry about inflation to begin with! However, less than half of working Americans ever even ask for a raise, and about 30% of them are uncomfortable negotiating salary.

Start your career on the right foot by successfully negotiating the salary offer of your very first job. Three out of four U.S. employers typically have room to increase their first salary offers by 5% to 10% during negotiations, but only 38% of applicants negotiate those first salary offers. Let's imagine that your first salary offer was $38,000, that would mean that you have the potential of increasing that offer from $39,900 to $41,800. Given the historical inflation average of 3% per year, you have the potential of covering inflation for 40 months just by negotiating your first salary offer.

And things only get better after that.

By bumping up your salary from the start, you're increasing your chances of future raises. As your salary grows over time, so does your probability of getting a raise. For example, people making $40,000 to $50,000 have about a 40% chance of receiving that raise they requested and people making $60,000 to $70,000 have about a 50% chance.

While there are other factors that may influence pay raises, the main one is the decision to request better compensation. From U.S. workers asking for a raise, 75% of them get something: 44% of them get what they asked for and 31% of them receive a smaller amount. Getting at least a small raise is a very smart strategy to protect yourself from inflation because inflation erodes the value of your dollars year after year.

What are other ways to protect yourself from inflation?

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