Provided by IMC! Peer Mentor: Nicholas Howard
Financial Stability
As young adults, either in school or the workforce, the decisions we make and habits we form in the present day will have an astronomical impact on our futures. Many young adults have goals and aspirations for their futures – getting a dream job, finding a spouse, saving for retirement, starting a family, or traveling the country or world – and there’s one common denominator of all these goals: financial stability.
Being financially stable enables us to not only afford our recurring expenses, but also save for the future, which allows us to achieve the goals we set for ourselves. As a young adult, the singular best way to achieve financial stability is to invest in your future. Putting a little money from each paycheck into a savings or checking account is a great habit to build, but unfortunately, money sitting in an interest-bearing savings or checking account does not have a high enough interest rate to outperform inflation in the long term. Keeping some money in a highly liquid account, such as a savings or checking account, allows for easy withdrawals to pay expenses, but placing another chunk into an investment account will allow for higher yields in the long term, and will allow your money to “work for you”, gaining interest and leading to larger savings for the future.
Market Inflation
While money in investments has more earning potential than money in a savings account, the current state of inflation in the US economy poses a significant threat to savings, and even investments. According to a February 10th Bloomberg article by Reade Pickert, the annual inflation rate has risen to 7.5 percent from January 2021, and inflation rose 0.6 percent month to month from December 2021. With this inflation, the highest price hikes have been seen in food, electricity, and housing costs (Pickert, 2022).
With annual inflation eclipsing 7.5 percent, investors are concerned with how that will impact their investments long term. A reasonable return expectation for the S&P 500 (the 500 largest and most profitable companies in the US) is 8 to 10 percent per year, and with inflation as high as 7.5 percent, returns can reach net-zero for many investors.
Investing as a Young Adult
According to a January 2022 article by Investopedia titled “The Best Investments for Young Adults”, young investors saving for retirement have the advantage of time on their side – if young people invest in the present, years of continued investing and compound interest contribute to higher yields in the future. Investing in stocks and real estate usually gain value faster than the rate of inflation, as do many portfolios like IRAs and 401(k)s (Cussen, 2022). However, while one may expect 8 to 10 percent gains in their IRA (Individual Retirement Account), market inflation nearly matching those gains can cause little-to-no increase in value during periods of higher inflation than average.
Hedging Investments Against Inflation
Now, while investments in stocks, real estate, and retirement accounts will still vastly outperform money in a savings or checking account, there are some options investors can explore to protect their investments from the risk of high inflation rates. A January 2022 article from Investopedia titled “9 Asset Classes for Protection Against Inflation” outlines investment options that are less sensitive to inflation or increase in value due to inflation that investors can use to hedge against inflation risk to their portfolios. Notably in these investment options are Gold, the 60/40 Stock/Bond Portfolio, and Real Estate Investment Trusts (Peters, 2022).
Gold is a strong currency because it is a real, physical asset, and tends to hold its value as well. Inflation is caused by price increases of goods and services, and thus, the price of Gold will increase with inflation. Although holding Gold will not pay out dividends or interest, it won’t lose as much value as some stocks and other investments that are highly sensitive to inflation and interest rates. Holding some gold can protect against inflation and keep a diverse portfolio (Peters, 2022).
Next, the 60/40 stock/bond portfolio can hedge against inflation because it is a safe investment option that focuses on a traditional mix of stocks and bonds. With inflation rising, the Federal Reserve is looking to increase interest rates, and some investments react differently to interest rate hikes than others. Stocks, while having a large growth potential, tend to react adversely to increased interest rates, thus, if rates increase, stock prices tend to decrease. However, when investing in a safe mix of stocks, those prices tend to stay relatively stable during those times. Bond prices act differently – when rates increase, bond prices increase, as well as their yield to maturity (YTM). If the Fed increases interest rates, the value of many bonds will increase, and help beat inflation. Investing in a 60/40 stock/bond portfolio can hedge against market volatility and inflation, however, it will underperform long-term, so focusing on this in the short-term while inflation is high may be a smart option (Peters, 2022).
Finally, Real Estate Investment Trusts (REITs), can be smart investments to hedge against inflation. These are companies that own and operate real estate as a source of their income (Peters, 2022). While inflation rises, the prices of property as well as rent tend to increase, so these REITs can increase in value during a time of inflation. REITs can be another option for a more diversified portfolio and help investors hedge against inflation.
Key Takeaways
All in all, there are many ways young adults can save for their future and become more financially stable. One might ask, how does inflation impact my life anyway? Or, I have enough in savings, why risk my money investing? As we move forward, please take away three things:
1) Money in savings is always safer than money under your mattress, and in the current state of the economy, money invested and earning interest is safer than sitting in a savings account that will not outperform inflation.
2) It is important to keep money for expenses in a savings or checking account, but a safe and quality way to protect that money form losing value is to invest it.
3) The smartest and least-risky way to invest is for the long-term, and growth investments, especially in retirement accounts can be a great vehicle. However, during a time of extremely high inflation, keeping a diverse portfolio and investing in options that are less sensitive to inflation, or increase in value due to inflation, can help stabilize long-term growth of a portfolio.
References
Cussen, M. (2022, January 21). The Best Investments for Young Adults. Retrieved from https://www.investopedia.com/articles/younginvestors/12/best-investments-for-young-people.asp
Peters, K. (2022, January 7). 9 Asset Classes for Protection Against Inflation. Retrieved from https://www.investopedia.com/articles/investing/081315/9-top-assets-protection-against-inflation.asp
Pickert, R. (2022, February 10). U.S. Inflation Charges Higher With Larger-Than-Forecast Gain. Retrieved from https://www.bloomberg.com/news/articles/2022-02-10/u-s-inflation-charges-higher-with-larger-than-forecast-gain
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