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Fending Off Inflation

James McGlynn, 1:15 am ET

I REMEMBER 40 YEARS ago listening to Salomon Brothers economist Henry Kaufman bemoaning government deficits and predicting higher interest rates as a result. We institutional investors would gather in a room to listen to his declarations through a “squawk box” intercom system—because conference calls weren’t yet a thing.

Federal Reserve Chair Paul Volcker was in the process of wringing inflation out of the financial system by raising the federal funds rate so high that investors would rather hold cash investments than spend money. For everyday investors, money-market mutual funds were the go-to investment. I would mail checks to Fidelity Investments, whose money fund yielded more than 15% while also offering complete liquidity. If short-term interest rates rose—which they did—I would earn even more. Stodgy bank accounts and certificates of deposit were no match.

Today, it seems Series I savings bonds are the modern-day equivalent of the 1980s money market fund. Even though buyers are limited to $10,000 per calendar year, the 7%-plus yield on offer seems as popular today as the money market funds of 40 years ago.

Many commentators also recommend Treasury Inflation-Protected Securities, or TIPS, as a great inflation hedge. But since the Federal Reserve purchased these bonds as part of its efforts at quantitative easing, they’re currently priced to return less than inflation, unlike I bonds, which should climb in lockstep with the Consumer Price Index.

What else can you do, besides buying Series I savings bonds, to protect yourself from inflation? Here are four other things I’ve done or plan to do.

First, I refinanced my mortgage with a 15-year loan at 2.375%. That rate is well below the inflation rate, plus I’ll be repaying the mortgage with depreciated dollars and the home itself should act as an inflation hedge. Since I refinanced, 15-year mortgage rates have jumped to 4.4%, but that’s still comfortably below the current 8.5% annual inflation rate.

Second, if interest rates continue to rise, I can buy more Series I savings bonds next year or I could buy one-year Treasurys. The latter currently yield 2%, but that should climb as the Federal Reserve raises short-term interest rates.

Third, I have another fixed-income investment—in the form of my whole-life insurance policy. The policy’s cash value is currently earning around 3.5%. As interest rates rise, the cash value won’t decline, unlike bond prices. In fact, with the insurance company able to invest at higher yields, I expect my cash value to start earning more than 3.5%. I prefer investments like Series I savings bonds, whole-life insurance and short-term Treasury notes to bond mutual funds, which own conventional bonds that could suffer big losses if interest rates continue to climb.

Finally, another excellent inflation hedge is Social Security, whose payments are tied to inflation. The cost-of-living adjustment for 2022 was 5.9% and there’s a good chance it’ll be even higher next year. I plan to wait to collect Social Security until age 70 so I maximize this inflation-protected stream of income. The larger my Social Security benefit, the more dollars I’ll receive with every cost-of-living increase.

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tshort
tshort
2 months ago

Nice rundown on the available options – none of them are very appealing, but it is what it is.

People might wish to consider one more option that I’ve recently learned about: MYGAs. Multi-year guaranteed annuities are yielding over 3%, varying by how long their term is. So you can ladder them the way people have done in the past with CDs or bonds.

Don’t let the “A-word” put you off – these are a very different instrument than traditional annuities. Worth checking out.

James McGlynn CFA RICP®
James McGlynn CFA RICP®
2 months ago
Reply to  tshort

Yes can do MYGA’s for a little more yield if you go out 3 years. The I-bond is super appealing but a limited amount.

Rick Connor
Rick Connor
2 months ago

Thanks for the good article James. I especially agree with the last part – with bonds not doing much I’d rather spend them and let SS grow.

james voorhies
james voorhies
2 months ago

Really appreciate your articles over the last couple of years. Always informative and make me think outside my normal comfort area. I have started looking at annuities since your earlier article.

Since you have experience with Treasury Notes, do you recommend Treasury Direct, a banker or a broker for the purchase? Are you seeking a specific interest rate or are you going with the market amount? I also noticed on the Treasury Direct site that when bidding the note may cost more at auction than the actual face value of the note upon maturity. Do you consider this or do you just go with the flow?

James McGlynn CFA RICP®
James McGlynn CFA RICP®
2 months ago
Reply to  james voorhies

Thanks for your comments James. Since I now have an account at Treasury Direct to buy the I-Bonds it was pretty easy to start buying the 52 week Tbills. I’m not sure what you mean about paying more than face value. The treasury note I purchased was at a 1.9% discount to the face amount. Upon maturity I will receive the face amount. The difference is the interest income. There are auction dates listed and I chose the 52 week bill since the yield was in excess of my money market account but matures in just a year. I plan to make more 1 year treasury purchases at whatever rates are available at the time-unless money market rates rise sufficiently.

Michael1
Michael1
2 months ago

A consideration re buying T-bills through Treasury Direct versus a broker: If you buy through a broker, should you wish to sell them, you just do so like any other security. I believe if you buy at Treasury Direct, then before you can sell, you must submit a form to TD to have them transferred to a broker, then once there you can sell.

Even if you intend to hold until maturity, it’s worth being aware of this.

Michael1
Michael1
2 months ago

Nice article. On the one year Treasury, is there any reason to opt for the highest one year CD one can find instead?

Aside from knowing more precisely the cost of getting the CD money back before maturity, I can’t think of a meaningful way the CD wins.

James McGlynn CFA RICP®
James McGlynn CFA RICP®
2 months ago
Reply to  Michael1

Treasury is higher quality and pays more. Banks are counting on inertia and cd holders not wanting to change.

5Flavors
5Flavors
2 months ago

If you live in a state with a state income tax you avoid that with the treasury and ibond

Michael1
Michael1
2 months ago

One other thing, that I should have stated better in my first comment – not only are we unable to know the precise cost of selling a T-bill before maturity, but this can actually result in a loss of principal, unlike redeeming a CD early.

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