5 Tips to Stay Ahead of Inflation

Economic inflation, like death and taxes, is a fact of life. Inflation is when the general level of prices in a given economy rises over time, which in turn causes the amount of money consumers pay for goods and services to increase. The net effect is that the buying power of consumers decreases because they are able to buy fewer goods with the same amount of money. In an economy that is healthy (and in many that are unhealthy), there is usually some level of inflation.

For investing, inflation is a big concern. Since inflation continually erodes buying power, money that is spent today ends up being worth more than money that's spent in the future. This means that investors need to be careful that they are earning enough to stay ahead of inflation, or it is mostly pointless to invest the money in the first place.

Here are five tips that can help smart investors beat inflation.

How to stay ahead of inflation

Tip #1: Earn more than the inflation rate

This is the golden rule of staying ahead of inflation. To beat inflation when investing for the long term, make sure that your investments have a higher rate of return than inflation is taking away.

For example, assume that the inflation rate is 4%. This means you need to be returning at least 4.01% or more on your investments, or your overall portfolio will be losing buying power.

To do this, you must know two things. First, you need to know the current rate of inflation, which you can find on InflationData.com. Secondly, you need to know how much your investments are making. This information should be available from your broker or your company’s human resources director, if you have a company-sponsored 401(k) plan.

Then make sure that you are earning more than the inflation rate. If you're not, you may need to change your investments.

Tip #2: Consider assuming more risk

The only way to stay ahead of inflation is to earn more than inflation takes away. One way you can attempt to do this is to take on more risk in your investments, if you are not planning on retiring in the next five years. While risk is normally a good thing to minimize, sometimes you need to assume a little bit more so that you can get a higher rate of return.

Based on your risk tolerance, strongly consider some investments which offer a little more risk. If several of the higher risk investments do well, you can always put money into more stable assets later to preserve that money because you will be earning enough with your riskier investments to make up for it.

Tip #3: Start saving early

Starting to invest early is important for several reasons. Perhaps the most important reason is that the longer the money has been invested, the more interest it will accrue; and the more interest it accrues, the more money there will be to earn further interest, and so on.

In terms of beating inflation, investing early on is important because your money will have greater buying power and you should have more of it. As long as your investments are actually beating inflation, getting money in sooner should ensure that you will have more of it later.

More articles from AllBusiness.com:

Tip #4: Look for inflation funds

Investment expert Bryan Perry advances a novel idea for beating inflation. He suggests investing in a specific fund, in this case the SPDR Barclays Capital TIPS fund which bases its investments on inflation-indexed assets. While Perry makes a strong argument for this particular fund, technically any inflation-protected fund (e.g., the Vanguard Inflation-Protected Securities Fund) should offer the same benefits.

This type of investment is a good way to avoid inflation because the sole purpose is to maintain the value after inflation. In fact, many of these types of securities invest only in federal or international government-backed securities, which may themselves be protected from inflation. These funds are still long-term investments, and like all investments, they do carry some amount of risk.

Tip #5: Consume less

Consuming less is a way to avoid the sting of inflation. The problem with inflation is that it causes a decrease in your overall buying power, which means that you will have to pay more to buy the same amount of goods. However, if you decrease the amount of goods that you purchase, inflation will not affect you as much. That is not to say that your buying power will increase; rather you will keep your spending constant and decrease what you buy.