As rates rise, inflation heats up and stocks plunge, you can still hedge your bets

Medora Lee
USA TODAY
  • The Fed's aggressively raising rates to fight inflation.
  • Stock indexes are down double digits this year and gyrating wildly.

Wild swings and double-digit stock index losses this year may cause some investors to ask whether cash is king these days. 

Financial advisers usually recommend stocks and bonds because they provide better returns in the long run, but if you can’t stomach the volatility, there are still ways to maximize cash.  

“Don’t stuff it in your mattress,” said Peter Casciotta, owner of Asset Management & Advisory Services of Lee County in Cape Coral, Florida. While inflation runs at a 40-year high, “that’s just losing money safely.” 

As the Federal Reserve is on an aggressive interest rate hiking cycle to combat that inflation, now might be the time to consider savings accounts, government securities and annuities instead, advisers said. 

Tried and true 

The Dow is down about 11% year-to-date, the S&P 500 dropped nearly 15%, and Nasdaq is off almost 24%. Even shoveling money into good old-fashioned savings, checking and money market accounts will earn you more. These rates have room to rise thanks to the Federal Reserve's rate hikes. 

If you go this route, be sure to check the interest rates on these accounts. They can vary widely, and you may be able to get more if you don’t need frequent access to your cash. 

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“You might get 0.03% to 0.04% at the corner bank but as high as 0.75% at an online bank,” Casciotta said. “Those are great rates, but you won’t have a lot of flexibility because you might be only allowed so many transactions per year. ” 

Government securities and bond basics 

Debt securities issued by the federal government to fund daily needs or special projects are among the safest assets because they are backed by the government. That means the full principal, or initial investment, will always be repaid upon maturity.  

Holding short-term T-bills, whose terms range from a few days to 52 weeks, is like holding cash because they are liquid enough that your money will be easily accessible, but you earn a small return on them, advisers said. Returns vary depending on the duration of the T-bill. 

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For a bit more return, consider an ultra-short bond fund that invests in a wide range of securities, including corporate debt, government securities, mortgage-backed securities and other asset-backed securities. They aren't guaranteed or insured by the Federal Deposit Insurance Corp. or any other government agency, but they're “a good way to obtain more yield but remain liquid – especially if you foresee not needing those funds, earning a higher yield, for the next six to 18 months,” said Julie Virta, certified financial planner and senior financial adviser with Vanguard Personal Advisor Services. 

Although these investments beat returns from stock indexes this year, none will keep pace with surging inflation. In the 12 months through March, consumer prices rose 8.5%.  

Coping with inflation 

Investors, seeking to protect their money against inflation, consider I Bonds and Treasury Inflation Protected Securities, or TIPS.  

I Bonds offer a fixed rate and an inflation rate that’s set twice a year based on the consumer inflation rate. They’ve gotten a lot of attention lately because for the bonds issued from May through October, the combined rate is 9.62%. If inflation doesn’t rise beyond that, investors will come out ahead. 

They’re “arguably the safest inflation-adjusted yield available today,” Christine Benz, Morningstar director of personal finance, wrote in a report. 

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There are drawbacks. They pay out only at the 30-year maturity, so there’s no regular income. They can be cashed out in 12 months after purchase, but if they are redeemed within five years, you’ll lose three months’ worth of interest. 

Individuals can buy and redeem them only from the Treasury – $10,000 worth with an additional $5,000 available through tax refunds.

TIPS help protect money against inflation, but the principal, instead of the interest rate, is adjusted for inflation. Both individuals and institutions can buy and sell these bonds, which means you don’t have to wait to redeem them. 

TIPS are attractive for larger investors since the investment cap is in the millions.  Their regular, semiannual interest payments are enticing for people seeking current income

But beware, TIPS have a major tax disadvantage. “TIPS investors pay tax on their income payments as well as the inflation adjustment made to their principal values, making them a far better choice for tax-sheltered accounts like your IRA or 401(k) than your taxable account,” Benz said. 

Equity indexed annuities 

For those with a longer time horizon, equity-indexed annuities, offered through insurance companies, have attributes of both stock and bond investments. Like bonds, they promise some fixed rate of return, but like stocks, payments increase with a rise in the stock index.

In exchange for that guaranteed rate of return, your gains are usually limited. That may be OK if you play it conservatively, Casciotta said. 

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Each contract is different and can be complicated, so read carefully or consult with an adviser, some warn. Because contracts vary between insurers, they’re almost impossible to research to find the best value or know their expense ratios. If you take withdrawals early, you may have to pay a steep fee, or if you take all or part of your money from tax-deferred indexed annuities before age 59½, you may have to pay a 10% federal tax penalty. 

Medora Lee is a money, markets, and personal finance reporter at USA TODAY. You can reach her at mjlee@usatoday.com and subscribe to our free Daily Money newsletter for personal finance tips and business news every Monday through Friday morning.