401(k), IRA, CDs good bets against inflation
$1 million might sound like enough to retire with today, but by retirement, it’ll be worth less than you might think. The reason is inflation, and it affects how you plan for the future.
Here’s what inflation is ...
Broadly speaking, inflation is the increase in overall prices for goods and services in an economy. You’ll need more money tomorrow to buy the same things you buy today.
“Inflation is the silent killer of your financial plan,” says Derek Brainard, manager of education services at AccessLex Institute, a nonprofit that helps law students understand their finances.
When putting away money for retirement, Brainard says, “you might need to be saving a lot more than you think because of inflation.”
The long-term average rate of inflation is between 2 and 4 percent annually, based on data from the Bureau of Labor Statistics.
... and here’s how to beat it
You can’t stop inflation, but you can make your money work better for you:
❚ Invest for retirement with a
401(k) or IRA: You might already do this, but you might not know why it matters: These accounts are your best bet for earning long-term returns that beat inflation.
Investing in stocks through brokerage accounts such as 401(k)s and IRAs has led to an average return in the past century of about 10 percent annually. When you factor in inflation, that leaves the real return closer to 6 to
8 percent.
❚ For short-term savings, find a high-yield certificate of deposit: Some online banks and credit unions have one-year CDs with annual percentage yields higher than 2 percent and five-year CDs with APYs over 3 percent. These federally insured accounts lock up funds for a fixed period; they’re best for money you don’t need for months or years.
Keep emergency fund separate
You also need savings outside of CDs and brokerage accounts to cover emergencies.
Dana Twight, a Seattle-based certified financial planner and owner of Twight Financial Education, says, “Your emergency fund’s purpose is not to beat inflation.” Rather, it’s for easy access to money when you need it. A regular savings account is easier to withdraw from than a CD or investment account.
An emergency fund should cover three to six months of living expenses, but “that’s based on the costs today,” Brainard says. “It’s important to revisit that (number) every single year.”
Should I worry about inflation?
A little inflation is not bad. “Around 2 percent” is generally an acceptable rate, according to the Federal Reserve. And it helps stave off deflation, which is when prices and even wages can fall, which happened during the Great Depression.