How Could a Changing Economy Affect Your Savings?
Changes in the American economy not only affect jobs and wages, they often have a direct impact on your savings. And there’s no more likely time for economic change than at the beginning of a new presidential administration. While no one can predict the effects the Trump administration will have on the American economy, it's vital that you understand how changes in interest rates and inflation can affect your savings. That way, you’ll know how to prepare yourself for the future.
Changes in Interest Rates
Higher interest rates mean a higher rate of return on interest-paying investments like savings accounts, savings bonds, Treasury Bills and Certificates of Deposit (CDs).
Edward Kohlhepp, CFP, from Doylestown, Pennsylvania, says that high interest rates can be good for your savings provided you have your money in interest-earning investments. “Rates of return for savings, money market accounts and CDs will rise as long as interest rates continue to rise,” notes Kohlhepp. “This will encourage people to save more, generally a good thing.”
When interest rates go down, interest-paying investments earn less. This is when people tend to invest their money in stocks and mutual funds. For example, after the recession hit in 2008, the government responded by reducing interest rates. As a result, people moved their money into stocks and mutual funds, prompting huge gains in the stock market.
Changes in Inflation
Periods of high inflation can hugely impact your savings because they erode the value of every dollar you've set aside. For example, if you saved $1,000 to buy something next year and inflation was at 3 percent, after one year you would need an additional $30 to buy that same item. After two years, the item would cost $1,060.90 because the inflation compounds each year. After 10 years, the same item would cost $1,343.90.
Provided that interest rates are higher than inflation rates, your savings will grow. Unfortunately, interest rates don't always keep up with inflation, and when they do, the net gain is minimal. For example, if you earn 4 percent interest on your savings when inflation is at 3 percent, your money is really growing only by 1 percent.
Protecting Against Economic Changes
Financial advisers offer a range of advice for protecting against inflation. Investing in commodities like gold and silver is one strategy, while stocks and mutual fund investments are another. These types of investments have often proved to be a good hedge against inflation over the long term, but they can go up and down dramatically over the short term.
For investors with a low threshold for risk, such as anyone planning to retire in the near future, Treasury Inflation-Protected Securities (TIPS) may be a better option. TIPS are a type of Treasury Bill issued by the federal government in terms of 5, 10 and 30 years that are indexed for inflation.
To protect your long-term savings from the ups and downs of inflation and fluctuating interest rates, a strategy to consider is to have a balanced portfolio with money spread out in different investments, such as Treasury Bills, bonds, mutual funds and CDs. The research and analysis tools in Quicken Premier Edition's investment portfolio can help you select and manage a multitude of varied investments.