How Investments Can Help You Beat Inflation and Build Your Nest Egg
In today’s bear market, with the S&P 500 down a quarter for the year, many customers are wondering: what are the benefits of investing if returns aren’t guaranteed? But investing, by definition, is all about long-term commitment. Investments you make today may not make you rich tomorrow, but will still pay off with dividends years down the line.
However, investing isn’t just about making money, it’s also about achieving financial stability—in the face of inflation, market volatility, and unforeseen circumstances. Understanding what investments will work best for you and your family, given your needs and unique financial circumstances, is key to creating an effective plan that allows you to do just that. In this post we’ll discuss common investment goals, and the different ways you can achieve them, working with an advisor to build a portfolio of investments that’s right for you. But first, let’s start with a frequently asked question:
Why isn’t just saving money good enough?
The hard truth is, for most people, simply accumulating your extra income isn’t going to be sufficient for long term financial stability. To prepare both for retirement and unexpected circumstances that can cause financial hardship, you don’t just need your money to accumulate, you need it to grow. That’s because, over time, no matter how much you save, those dollars will lose value due to inflation.
Although wages have increased at a faster pace than usual in the past few years, recent high rates of inflation have resulted in an effective wage decline. As Reuters writes, “real earnings growth is negative [because] the latest rates of annual consumer price inflation and nominal wage growth are 7.9% and 5.8%.” In other words, adjusted for inflation, wages are worth 2% less today, even though they have increased almost 6% recently
Investing allows you to put your money to work by earning interest on your savings, instead of simply accumulating it in an account and seeing its buying power diminish over time. As Forbes explains, “Your long-term investments will need to earn at least 3.5%, the average U.S. inflation rate going back to 1960, to keep from losing ground.” And in order for your financial assets to grow, you’ll need to be earning an average interest rate well above this number.
How Investments Outpace Traditional Savings
Savings accounts are great places to set aside money for smaller, short-term goals, when the benefit of long-term yields doesn’t outweigh the need for short-term accessibility. For instance, if you are saving a portion of each paycheck for a car that you will buy within a year or so, it wouldn’t make sense to put that money into an investment account, which may gain a few bucks in returns, but could lose your principal amount, should the stock market take a hit. But when you save for long-term goals that are many years away, from retirement to college for your kids, those short-term market swings are offset by long-term gains. Over time, the interest on your larger pool of savings will be significant, not only keeping up with inflation, but growing your wealth, too. Let’s dissect why traditional savings accounts act as poor tools for long-term savings.
First, savings accounts typically don’t earn a lot of interest. Because you can withdraw money from your savings account with few restrictions, savings accounts are less useful to your bank for their own investment purposes. As a result, banks rarely offer significant interest rates on their traditional savings accounts. A typical savings account offers around .6% interest (yes, less than 1%)—and remember, it needs to be above 3.7% for that money to retain its buying power. While savings accounts allow you to accumulate money outside of your regular spending accounts for short-term goals, they won’t increase your wealth or hold value over time.
Investments require long term commitment, but the payoff is far greater. Markets fluctuate in the short-term: property values may rise and fall during the course of a year and the stock market as a whole may dip for months on end. Year-to-year, your rate of return will vary. But if you stick it out, over time yields tend to average over 10% a year for stock market investments and about 4.5% for real estate. And if you do want guaranteed returns, like those offered by government or corporate bonds, you’ll have to park your funds for a while—long enough to ride out those short-term market fluctuations. There is no such thing as a guaranteed, get-rich-quick investment. When you invest to grow your wealth, you will be investing with the future in mind.
However, even though investments tend to have decent returns in the long run, it’s important to consult with a trusted, wealth management expert in order to build a portfolio that mitigates risk by having a mixture of types of investments. Based on your age and risk tolerance, your advisor will create a combination of higher-risk, higher-return investments, and lower-risk, lower return investments. If you’re nearing retirement age, you will probably prefer to have more of the latter, so you can depend on your funds being there when you need them. Services like Nest Egg at Flanagan State Bank can work with you to create the right portfolio for your financial goals and needs.
Investing for Retirement or Education
Retirement is perhaps the most common long-term investment goal for Americans—everyone hopes to retire one day, and it’s well-known that counting on Social Security benefits to be your primary source of income can be hard to do. In fact, only 12% of men and 15% of women rely on these benefits for more than 90% of their income, according to the Social Security Administration. Saving in retirement accounts is pivotal for most Americans’ retirement strategies, and, as research by the Federal Reserve Bank shows, 54% of Americans have savings in a defined contribution pension (like a 401(k)), 33% have savings in an IRA, while only 9% of Americans are investing for their retirement in alternatives like business or real estate.
401(k)s (and 403(b)s, if you work for a nonprofit) are offered through your place of employment, and allow you to reduce your current tax burden by setting aside some portion of your income, pre-tax, each paycheck. Many employers offer some level of match on your savings, and while most experts recommend that you save 10% of your income, the maximum amount or money you can invest each year is quite high: $61,000 for the 2022 tax season, and $67,500 if you’re over 50, per the IRS. Additionally, most accounts allow you to choose how you would like to allocate your assets, from a set selection of funds that prioritize growth, stability, or a healthy or a combination of both. However, you can only contribute to a workplace IRA while you are employed there. If you leave the job, while you keep your funds (and your employee match if it’s been fully vested), you can no longer make contributions to the account.
If your place of employment doesn’t offer retirement options, or you would like to save additional funds outside of your workplace retirement plan, opening a Traditional or Roth IRA (Individual Retirement Account) is another popular choice. Although the maximum amount of income you can save each year is restricted—$6,000 for individuals under 50—each plan can offer significant tax benefits, as well as greater flexibility for early withdrawals (no penalty if used for certain qualifying life events, including a first home purchase). Traditional IRAs offer the same advantages of 401(k), reducing your tax burden the year you make the contribution. Contributions to Roth IRAs, on the other hand, don’t give you any tax savings in the current tax year, but when you start making withdrawals, you won’t be taxed on those distributions. This can save you a lot of money come tax time, once you are retired.
Retirement isn’t the only common investment goal, nor is it the only kind of investment with specific, tax-advantaged accounts. If you are looking to invest for education expenses, there are accounts designed just for saving for college. In Illinois, you can open a Bright Start 529 plan for yourself, child, grandchild, or another benefactor, and enjoy state tax deductions of up to $10,000 ($20,000 if you are married and filing jointly). Plans are professionally managed with investments selected based on the needs and age of the benefactor and your own risk tolerance.
Investing to Meet All Your Financial Goals
Retirement and education accounts are designed to safeguard the funds you contribute as they accumulate and grow, meaning that you won’t be able to access them like you would with a typical savings account. For example, if you withdraw any funds from a 401(k) or IRA before age 59½, you may pay a penalty, and possibly owe federal or state income taxes. If you would like to invest for other financial goals, from building wealth to supplementing your day-to-day income, you’ll need to explore other options.
Common investments include the direct purchase of bonds (government and corporate) and U.S. Stocks that are traded on one of the stock exchanges, as well as purchasing shares of mutual funds and exchange-traded funds (ETFs). Stocks, which allow you to buy partial ownership of companies and share in their profits, are often chosen for the possibility of higher short-term returns (though there are no guarantees). The benefits of investing in corporations through bonds, however, include lower risk and more reliable returns—but they do tend to have lower yields than the stock market as a whole. And Government (Treasury) Bonds carry even less risk and even smaller returns. If you are looking for an easy balance of risk and reward, or a more passive approach to investing, mutual funds and ETFs might be right for you. These funds, managed by a fund manager, will contain an assortment of stocks and bonds, designed to balance short-term gains with long-term stability.
Keep in mind that investing always carries some level of risk or some degree of inaccessibility; whatever money you choose to invest should be money that you don’t need in the near-term. And if you’re banking on your riskier investments for future income, for instance to supplement retirement benefits, make sure there’s enough time before your retirement to recoup potential losses. Working with a financial advisor to create an effective strategy for long-term investment is key.
In addition to the above market investments, you may also want to consider other possibilities, including purchasing property or investing in businesses for both generating income and building wealth. As we mentioned above, property tends to have a decent rate of return, appreciating about 4.5% in value each year. But above and beyond the increase in value, there are other benefits of investing in real estate including earning a passive form of income and earning tax benefits for property improvements. If you don’t have the funds upfront, you may be able to use a conventional home loan or home equity loan to pay for your investment property. If you buy a property with a history of rental, you may even be able to use the expected rental income as part of your own income for qualification. Check out our Mortgage Loans page to learn more about home loans through Flanagan State Bank.
You may also consider partnering or providing funding for a new or growing business as an alternative form of investment. If the business is successful, having a stake in its growth can be a lucrative venture, and profits can even provide passive income for you. But businesses have a 50% failure rate within five years, meaning that they can be on the riskier side, therefore it’s important to consider business investments as part of a larger portfolio that includes less risky opinions as well. If you’re considering it, follow these 4 Must-Do’s Before Investing in a Local Business from the U.S. News and World Report before you sink any cash into a specific venture.
Start Investing Today
The benefits of investing early cannot be overstated. The longer you have to invest, the longer your funds have to grow, and the more likely they are to weather short-term market fluctuations. But even if you are nearing retirement age, it’s never too late to make your money work for you—to get ahead of inflation and to give your income a boost.
Whether you are a recent college graduate, saving for your own children’s college, or looking to create a wealth management plan to meet your needs today and for years to come, Flanagan State Bank can help make sound, personalized investment decisions. Call us at 1-815-796-2264 or make an appointment online to see what an experienced Nest Egg Advisor can do for you!