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Ask the expert: Are money market accounts a good hedge against inflation?

November 25, 2010

By Richard Barrington | MoneyRates.com Senior Financial Analyst, CFA

Q: I am concerned that inflation is going to come back in a big way. What would be the safest thing to be in if that happens: stocks, bonds, or money market accounts?

A: Inflation is a destructive force which fortunately has been fairly benign for nearly thirty years now. However, if you are curious about what might happen if inflation flares up, there is a period of high inflation from the past you can look at as an example.

From the beginning of 1968 through the end of 1981, U.S. inflation averaged 7.6 percent a year, reaching a high of 13.31 percent in 1979. Over the course of these fourteen years of high inflation, large-cap stocks averaged just 6.0 percent a year, and long-term Treasuries averaged just 3.3 percent a year. In other words, both lost ground to inflation over this period.

It was short-term T-bills that came closest to hanging in there against inflation during this period, averaged 7.2 percent a year while inflation averaged 7.6 percent. You could expect savings accounts or money market accounts to behave most similarly to T-bills, since both represent short-term interest rates.

Some takeaways from this are as follows:

  • 'Safe' is a relative term when high inflation strikes. It's more a matter of limiting damage than coming out ahead.
  • Staying short-term is the best immediate defense. Short-term vehicles like T-bills and money market accounts are at least able to adjust rapidly to changing conditions.
  • Long bonds have the toughest time when inflation rises. This would be especially true now, because bond yields are so low.
  • Stocks and bonds have other strengths. Stocks have had the highest returns when a full range of conditions is considered, and bonds should do very well when inflation is declining.

In short, if you think inflation is going to be rising, you could do much worse than T-bills or money market accounts.

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