Apart from market volatility, there are few things that frighten investors more than inflation.
No matter how much effort you've put into building wealth or saving for retirement, you could be in for a nasty surprise if you haven't taken inflation into account.
The Federal Reserve indicated in January that inflation would likely rise this year. And the latest report on inflation showed consumer prices climbing faster than economists predicted.
Time will tell whether rising inflation is a durable trend or a flash in the pan, says Greg McBride, CFA, Bankrate's chief financial analyst. Either way, investors are watching closely to see what happens.
Savers who tend to invest in certificates of deposit (CDs) should think about ways to protect their portfolios from inflation. At the very least, experts say you should consider building a CD ladder.
Laddering softens the blow
CD laddering is a simple concept. Instead of buying one CD at a time, you would buy a handful of them with different maturity dates.
Let's say, for example, that you want to buy 12-month, 18-month and 24-month CDs. When the 12-month CD comes due, you would reinvest your savings into a 24-month CD. And when your 18-month CD matures, you would also buy a 24-month CD and continue rolling your savings into new CDs.
The result? You'll regularly have access to money that you can reinvest to take advantage of rising interest rates. At best, you'll be keeping up with inflation, says John Hagensen, founder and managing director of Keystone Wealth Partners, a wealth management firm in Chandler, Arizona.
CD laddering can be an effective way to position yourself in the event that interest rates are increasing along with inflation. And you can set up your ladder depending on how quickly you expect interest rates and inflation to rise, says John Piershale, a wealth advisor at Piershale Financial Group, a firm in Crystal Lake, Illinois.
Investing in 1-year, 2-year, 3-year and 4-year CDs might make sense in a normal interest rate environment. But if rates and inflation are picking up, you should consider building a ladder that includes CDs with shorter terms, Piershale says.
"Laddering makes sense, but as a conservative investor, I would keep it on the short end because there's not much of a premium pickup to go longer, and if interest rates start rising, they'll have the opportunity to capture that upswing much faster," says Joe Heider, founder and president of Cirrus Wealth Management in Cleveland, Ohio.
Sticking to shorter terms is key in an inflationary environment when you're comparing other types of fixed-income investments, including bonds and treasuries.
Hedging against inflation
Laddering CDs and keeping your term lengths short can help when you're concerned about inflation. But in the long run, that's not enough.
Even among the most conservative investors, putting all of your assets into CDs or bonds isn't a good idea. In fact, avoiding risk by only choosing fixed-income investments is actually risky.
"In my opinion, they're actually putting themselves in many ways at more risk than someone who has some of their portfolio allocated to the stock market, which traditionally responds relatively well to inflation over time," Hagensen says.
Even for risk averse investors, it's best to be properly diversified. In other words, you can't have all of your eggs in one basket.
Stocks have historically been considered one of the best hedges against inflation. But that doesn't mean you should buy a single stock.
Instead, consider complementing the high-yield CDs in your portfolio with exchange-traded funds and index funds, Hagensen says. And find a fee-only financial adviser or fiduciary who can help you choose the right investments based on your financial goals and risk tolerance.