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How Can You "Play It Safe" But Still Beat Inflation?

06/23/2015 09:03 am ET | Updated Jun 21, 2016

By Paula Pant, WiserAdvisor.com contributor

You want to play it safe in the investment world. The agony of the recession is fresh in your mind. Your stomach churns at the thought of suffering 2008-style losses.

But you know that you can't stuff your money under a mattress. You need to produce some type of investment returns, however modest. After all, you also recognize that inflation is a real risk. If you let your money sit in a savings account - or even put it into a CD - it will lose purchasing power to inflation, and that's not a cost you'd like to bear.

What can you do? Read on for tips about how to play it safe while still protecting yourself from the wealth-eroding powers of inflation.

Why Play it Safe?

Before we launch into the 'how,' let's briefly discuss the 'why.' When is it appropriate to 'play it safe,' and when should you take a more aggressive strategy?

A few reasons to play it safe include:

Short timeline - If you need to access or withdraw your money within a relatively short time horizon, you'll want to stick with conservative investments. For example, if you're investing a large sum of money that you intend to use as the down payment on a house within the next 3 years, you'll want to protect the principal. By contrast, if you're investing with a long time horizon (10-20 years or more), you may favor a more aggressive initial approach, which gradually becomes more conservative over time.

Age - If you're nearing retirement age, you'll want to gradually decrease your risk profile, because you have a shorter timeline. If you're several decades away from retirement, it's prudent to design a more aggressive portfolio. You'll slowly re-allocate into a more conservative portfolio as you age.

Risk tolerance - Your personal risk tolerance plays an important role in your decision-making, as well. If you're likely to panic and sell at the bottom, you're better off in safer investments. Talk to a financial advisor to get a more clear assessment of your risk tolerance.

Emergency fund - You may want to keep your emergency fund in safe investments to increase liquidity and protect principal, but still protect it from the withering effects of inflation.

How Corrosive is Inflation?

Just how big of an impact does inflation carry? What number are we trying to beat?

Like the stock market, the average U.S. inflation rate is volatile. Between 1913 to 2013, the long-term annualized average inflation rate in the U.S. came to 3.22 percent.

However, within any given decade (10-year span) within that century, the average inflation rate fluctuated from a high of 9.8 percent (1913-1919) to a low of -2.08 percent, or deflation (1930-1939).

Inflation peaked again in the 1970's and remained high through the 1980's, but the last 25 years that have passed since 1990 have seen moderate and steady inflation, hovering within a tighter range of between 2.2 to 3.0 percent.

This data establishes a benchmark. You'll want to pinpoint investments that, at the very least, will return around 3 percent annually, in order to maintain a reasonable probability of keeping pace with inflation.

How Can You Invest to Beat Inflation?

All investments carry risk. That said, what are the relatively lower-risk investments that will give you a decent shot at fighting inflation?

TIPS - Treasury Inflation-Protected Securities, or TIPS, may be your safest bet.

Your security will price-adjust in accordance with both inflation and deflation, as measured by the Consumer Price Index. You have the option of either holding the security to maturity or selling it prior to maturity.

When the security matures, you're paid the higher of your inflation-adjusted principal or your original principal. In other words, your investment is protected from both inflation and deflation.

These securities are backed by the full faith and credit of the federal government, and can be found at treasurydirect.gov.

Target Date Funds - Target-date retirement funds are designed to allocate assets according to time horizon.

A Target Date 2020 fund, for example, is designed for investors who plan to retire (and therefore start withdrawing money) within the next five years. As a result, the investments will be allocated more conservatively. A Target Date 2065 fund, by contrast, will be much more aggressive.

The advantage to these funds is that you don't need to worry about asset allocation or rebalancing. The fund takes care of the maintenance on your behalf. Some brokerages have also started selling index-fund-based Target Date funds, which carry a low expense ratio.

Remember, you don't actually need to retire in the fund's stated year. An 18-year-old can invest a portion of her money into a Target Date 2020 fund, even though she's not retiring until 2065.

One caveat: Target Date funds are designed for individuals who will withdraw a small portion of the total account balance each year - not those who will withdraw the entire balance at once. If you need access to your entire principal, you may discover that even a near-date fund may be invested more aggressively than you'd like.

Personal Portfolio - If even a near-date Target Date fund is too aggressive for your taste, you could personally design a unique conservative portfolio that reflects your liquidity goals and risk tolerance. This portfolio may have a mix of low-fee, high-quality bonds, securities and other investments. It should be rebalanced periodically.

If you're not sure how to design this portfolio, you could ask a financial advisor or investment advisor to create, monitor and manage this type of portfolio on your behalf. The advisor will design it to maximize the potential for principal preservation while trying to outpace inflation.

Real Estate - As an asset class, real estate is renowned for its inflation-beating history. Home values and rental incomes both tend to keep pace with inflation, making real estate a strong contender for this type of goal.

But what about your goal of "playing it safe?"

If you have adequate funds to buy a house in cash, you remove risk associated with leveraging into a property. You'll further remove risk by purchasing Class A real estate (new construction in safe neighborhoods with high tenant quality and low turnover). Hire a licensed property manager to handle the day-to-day managerial aspects of your investment.

What if you don't have the funds to buy Class A properties in cash, or you don't want the responsibility associated with owning physical property? You could invest in Real Estate Investment Trusts, or REITs. Look for one with a strong track record that shows low fees, low volatility and healthy dividends.

Final Thoughts

There's no need to keep your money stuffed inside a mattress - and there's no need to lay awake at night, scared of the next market crash. Many investments will allow you to "play it safe" without keeping your money in cash or CDs.

Choose a style of investment that appeals to your personal goals and risk tolerance, monitor its performance, and seek outside assistance if needed. You can battle inflation without exposing yourself to undue risk. It's your money; don't let it slip away.

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