Coping With Potentially Higher Inflation Rates

Written by , May 30, 2011

Coping With Potentially Higher Inflation RatesGenerally speaking, inflation occurs when the price of goods and services increase over time. For consumers, inflation is usually considered to be a bad thing, because your money will buy fewer and fewer things. If your income is growing at a rate faster than the rate of inflation then you won’t have this reduced spending power. However, many workers are finding that their incomes aren’t rising fast enough to keep up.

From a saver’ s perspective, however, inflation isn’t a bad thing. Rising interest rates go hand in hand with rising inflation, including the interest rates that are available for savings products such as certificates of deposit and money market accounts.

During periods of increasing inflation, or in anticipation of such periods, there are a series of steps you can take with respect to your banking activities in order to mitigate the negative effects of inflation. Here is advice on what you should consider doing.

  • Consider building a CD Ladder. Since longer term income products tend to pay higher rates, one way to balance your goal of receiving the highest possible rates along with your desire to have money available to invest when rates move higher is through a “CD ladder.” In its most basic form, a CD ladder is where you divide your investment funds equally among CDs with varying maturity terms.

    For example, you might invest $1,000 in CDs that have maturities of one year, two years, three years, four years and five years. When your one year CD matures, and the interest rates for new CDs have moved higher, you invest those proceeds in a new five year CD. That way you have funds that become available each year for reinvestment, ready to put into a new long-term product with the highest available rates.

  • Adjustable Rate CDs. If you don’t want to manage a CD ladder, or if you want or need to go longer term with more of your funds, then consider a one-time adjustable rate CD. These products are offered by a number of banks, and usually have long-term maturities (usually two years or more). Their distinguishing feature is that you have the opportunity to “reset” your CD interest rate once during the term if the prevailing interest rates increase. This can be a great compromise between locking in a long term rate and not being frozen out of improving rates during the term.
  • In times of increasing inflation, it’s generally a good idea to keep your fixed-term income investments in products with relatively short maturity terms. Since interest rates for savings products tend to follow inflation rates upward, you don’t want to get locked into an interest rate for many years when you could be earning a higher rate later.
  • Finally, you can focus more on the flexibility side of the equation by keeping your money in higher yielding online savings or money market accounts. These products contain some restrictions on withdrawing your money, but offer interest rates that are significantly above the rates banks pay on traditional savings accounts. The interest rates on these accounts also tend to rise when inflation creeps up.
  • Inflation is one of those concepts that is often talked about and referred to, but frequently overlooked when individuals are assessing their financial situation or drawing up a new financial plan. You can use the techniques above to make sure that higher inflation doesn’t impact you quite as hard.

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