Where Should You Put Your Money When Inflation Is High?

high gas prices — Gas prices have been very high across the U.S., thanks to inflation and other pressures. Justin Sullivan/Getty Images

It's been a long time since Americans had to worry about inflation. Inflation is the rate at which prices go up in the economy and it's measured as a percentage increase from year to year. Inflation is why the average new car cost $3,000 in the late 1960s, but now sells for more than $47,000 (up from $40,000 in 2021). Inflation isn't a problem as long as it increases slowly and steadily, and wages are able to keep pace.

Between Great Recession of 2008 and the economic slowdown of 2020, the inflation rate wasn't above 3.8 percent and mostly stayed below 2 percent. In fact, you'd have to go back to the late 1970s and early 1980s to find double-digit inflation rates in the U.S.

But inflation began to climb in 2021, and in the past 12 months or so, it has shot up. In June 2022, the inflation rate rose a whopping 9.1 percent from June 2021, the Bureau of Labor Statistics reported. This was the fastest pace for inflation since November 1981, according to CNBC. Higher prices for groceries, gas and rent caused much of the inflation.

In 2021, the Fed and most economists blamed the dramatic jolt in inflation rates on the reopening of the U.S. economy after a yearlong pandemic. When the supply of things like used cars failed to match the sudden increase in demand, prices rose accordingly. Conventional wisdom was that prices would stabilize when the sluggish supply chain kicked back into high gear. But a year later, prices still remain high and the supply chain is still clogged. Russia's war in Ukraine (which is increasing energy costs), heavy demand for dining out and travel and big infusions of cash through government aid while the supply of goods and services remains limited, are just some of the reasons being given for inflation.

So, what if high inflation is here to stay, for months or even years to come? What can the average American do to protect their savings and investments against a slow and steady erosion of value? In 2021, we spoke to a pair of financial experts to identify the smartest (and dumbest) places to put your money when inflation is high.

How Inflation Can Hurt Your Finances

Governments and corporations worry a lot about inflation, but even the average American household will feel the sting if inflation keeps rising and stays that way.

"Inflation is definitely something to be concerned about," said Andrew Latham, managing editor at SuperMoney, a personal finance website. "If the prices for everything go up and household income doesn't, people will need to rethink their budgets and spending priorities, so it's a real issue."

While rising prices can definitely put a strain on the pocketbook, inflation is equally damaging to long-term savings. Because inflation was so low for so long, the Fed kept interest rates low to stimulate economic growth and higher overall employment. That meant that interest rates for savings accounts at the bank, or long-term saving instruments like CDs (certificates of deposit) and money market accounts were very, very low — like 1 percent or less.

If the money in your savings account grows at 1 percent a year, but the rate of inflation is 4 percent a year, then the value of your savings is actually shrinking by 3 percent a year. At that point, they should change the name from a savings account to a "losings" account.

Your Time Horizon Matters

There's risk to any type of investment, explained Patrick Geddes, co-founder and former CEO at Aperio Group, an investment management firm, and author of the book "Transparent Investing." People tend to be terrible at calculating risk and end up making rash financial decisions based on emotion instead of logic, which is true with inflation.

Headlines about high inflation are scary and they may cause investors to panic and make poor investment decisions like pulling all their money out of stocks and putting it somewhere "safe" like bonds or cash.

"Cash and bonds are the asset classes that are the most vulnerable to the scourge of inflation," said Geddes, since the low yields of bonds and the zero-yield of cash will get eaten up the fastest by rising inflation. "Historically, the asset classes with highest returns and the highest risk, like stocks, have typically been the best at countering inflation. The idea being that with stocks you're buying productive assets that, at least theoretically, can adjust to an inflationary environment."

The question is whether you're in a hurry to use the money or if you can wait. In investing, this is called your "time horizon." If you've saved up a bunch of money for a house that you plan on buying in the next year, then you have a short time horizon. The same is true if you plan to retire in two or three years. In those cases, it's smarter to keep your money in a low-yield bond or savings account, because the risk of high inflation is still lower than the risk of betting that money on the short-term performance of the stock market. (The stock market has been in a slump in the first half of 2022.)

"On the other hand, it's very well-understood advice that the longer your time horizon, the more risk you should take," said Geddes. "Looking at a 20-year holding period, the worst real return for stocks was better than the average real return for cash. In other words, cash is a disaster for a 20-year horizon and stocks are great."

Inflation Stock Picks: The More Boring the Better

Don't get carried away, though. Just because it's smarter to keep your money in stocks, it doesn't mean that you should try to predict how individual stocks will respond to inflationary pressures. Latham said that it's almost impossible to "beat the market" by making tons of individual stock trades. You're much better off investing in broad (and boring) index funds that mirror the overall performance of the market.

"A well-diversified fund will do OK in most markets, regardless of whether there's inflation or not," said Latham.

If you feel compelled to tweak your stock market investments, real estate is traditionally a smart bet during high inflation, said Latham. Few people have the cash on hand to buy a rental property, but you can invest in REITs (real estate investment trusts) that are traded on the stock exchange. If rental prices and property values go up with inflation, the stock prices of REITs are likely to rise and your investment is likely to grow.

Commodities can be another smart investment during inflationary periods. Prices for commodities like corn, soybeans or petroleum tend to rise quickly with higher inflation. That's why financial advisers call commodities a "hedge" against inflation. Since commodity prices can be volatile, though, it's wise not to go all-in on specific commodities, said Latham, but to invest in funds that track the entire commodities market.

What About Gold?

Gold is often advertised as another strong hedge against inflation, since gold and other precious metals are always in demand, whether or not inflation is rising or falling. But Latham points out that gold is generally a poorer hedge than something like a stock market index fund or a commodities market fund, which continuously generate a yield as prices go up. Gold only pays off when you sell it, and only if you're lucky enough to sell it for a gain.

"You're just hoping that the price of gold goes up so when you sell it you'll make a profit, but it's not guaranteed," said Latham. "You have to time the purchase and the sale perfectly."

Another downside to gold during periods of high inflation is that the Fed typically tries to counter inflation by raising interest rates. At that point, you're better off having cash stashed away in higher-yielding CDs and savings accounts than sitting on gold. As Reuters said, "Rising interest rates lift the opportunity cost of holding non-yielding bullion — why hold gold when you can be paid to hold cash?"

Note: Any financial decisions should be made in consultation with your investment adviser.