Which Low-Risk Investments Are Best for Inflation?

Quick Answer

When inflation is high, modifying your investment strategy can help preserve your purchasing power. Low-risk investments to consider may include:

Couple reviews investments amid inflation

From the grocery store to the gas pump, we're all feeling the effects of inflation. Consumer prices hit record highs in 2022, finishing the year up 6.5% from the previous year. When inflation is high, modifying your investment strategy can help preserve your purchasing power. That's important since rising prices mean that your dollars won't go as far. But you may not be comfortable assuming too much risk in your portfolio, especially if you're approaching retirement or are already retired.

While you cannot fully inflation-proof your portfolio, choosing lower-risk investments during turbulent times may help you weather the storm.

A Quick Word About Inflation and Interest Rates

In an attempt to cool inflation, the Federal Reserve raised the funds rate seven times in 2022. The idea is that consumers will have less money to spend on goods and services since they're paying more in interest, hopefully bringing the price of goods down. The funds rate heavily influences the cost of borrowing money. When the rate goes up, everything from credit card annual percentage rates (APRs) to mortgage rates to personal loan APRs tends to increase right along with it.

With regard to investing, rising rates typically drive down stock market returns. If consumers are spending less, that may translate to lower revenues—and lower profits—for companies. High borrowing costs can also stunt business growth. But rising interest rates can actually be good news for other investments. Savings accounts, money market accounts and certificates of deposit (CDs) tend to offer higher yields when interest rates are up, for example.

CDs

A CD is a unique type of investment. This savings vehicle pays out interest if you leave your money in the account for a predetermined amount of time. You'll likely be penalized for withdrawing funds before the maturity period expires. CDs are generally available in the following terms:

  • 1 month
  • 3 months
  • 6 months
  • 12 months
  • 24 months
  • 36 months
  • 48 months
  • 60 months

Longer terms usually translate to higher interest rates. When inflation is high and the Fed funds rate is up, you could earn a nice return with CDs. At the time of this writing, some are offering rates as high as 4.8%. CDs are available at financial institutions like banks and credit unions.

Pros of CDs

Cons of CDs

  • Some financial institutions have hefty minimum deposits for CDs.
  • CDs don't provide easy access to your money. You'll likely be hit with a penalty if you withdraw funds during the maturity period. The fee usually depends on the financial institution, the term length and interest. A five-year CD, for example, may charge 18 months' worth of interest.
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Money Market Accounts

A money market account blends characteristics of a checking account and savings account. It earns interest, but unlike a traditional savings account, you can easily withdraw funds—most come with a debit card or checkbook.

A money market account can be a good place to store your emergency fund or hold money for other savings goals, like a home down payment or travel fund. Interest rates are usually on the lower side, but more competitive rates are available right now. Some companies offer rates as high as 3.2% on balances under $100,000, and they may also offer no minimum account balance or monthly fee.

Pros of Money Market Accounts

  • Money market accounts allow for easy access to your funds, though some financial institutions may limit you to six withdrawals or transfers per month.
  • They offer moderate annual percentage yields (APYs) and are considered safe investments.

Cons of Money Market Accounts

  • Monthly fees and minimum balance requirements may apply.
  • Your monthly withdrawals may be limited.

Certain Real Estate Investments

Inflation has affected the U.S. rental market. The median monthly rent in December 2022 was $1,978, according to Rent.com. That's a 4.77% increase from the year before. Investment properties could be worthwhile for those who are up for the task. They typically require a larger down payment when compared to residential properties—20% to 30% is the norm. Interest rates also tend to be higher than a mortgage for a primary residence, and it's wise to have cash reserves on hand for maintenance and repairs. If the numbers make sense for you, rental properties could provide a steady stream of passive income.

Alternatively, you may choose to buy and flip real estate. Homes flipped in 2021 generated an average gross profit of around $65,000, according to property data provider ATTOM Data Solutions, with an average return on investment of 31%.

If you'd rather not deal with buying properties, you can explore a real estate investment trust (REIT). It allows you to invest in companies that own and operate income-producing properties without being wholly responsible for any individual property. REITs are often considered a safer way to invest in real estate.

Pros of Real Estate Investments

  • Rental properties can provide regular passive income, especially as inflation pushes rent prices upward.
  • Real estate investing might make sense for someone who has good credit and the cash reserves to bankroll it.

Cons of Real Estate Investments

  • If you own an investment property, you'll be responsible for upkeep and managing tenants.
  • Even if you screen your tenants, there's always the chance they could default on their rent.
  • The housing market is ever-changing. There's no guarantee that your investment will appreciate in value. In fact, you could lose money.

Short-Term Bonds

Short-term bonds typically mature in one to four years. A bond is a debt security. By purchasing one, you're lending money to the entity that issued it, such as a company, the U.S. Treasury or a local government. When the term ends, you'll recoup your initial investment plus interest.

Bond returns are usually less robust when compared to riskier assets like stocks, but they can be a viable option during times of high inflation. They're safe investments, and shorter terms provide liquidity. Investors can purchase bonds through a broker, directly from the issuer or invest in a bond mutual fund or exchange-traded fund.

Series I bonds, also known as inflation-linked savings bonds, may be particularly attractive. They're made up of two interest rates—one that's fixed and another that fluctuates with inflation. Series I bonds purchased until April 30, 2023, have a guaranteed return of 6.89%. You can purchase them through TreasuryDirect.gov.

Pros of Short-Term Bonds

  • Bonds can be a safe place to invest your money when inflation is high.
  • Series I bonds are easy to purchase and adjusted for inflation every six months.

Cons of Short-Term Bonds

  • Returns are usually lower than higher-risk investments. Over the last century, the stock market's average annual return has been about 10%.
  • They are less liquid than some other investments, such as money market accounts.

The Bottom Line

Low-risk investments may be more attractive when inflation is running high. The right ones can help preserve your purchasing power and diversify your portfolio. However, you'll likely need to take on some level of risk to meet your long-term financial goals. The best investment strategy for you will depend on your age, goals, risk tolerance and retirement horizon.

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