Inflation is here for the foreseeable future, and families and investors alike will know how devastating inflation is to wealth and income. This post by Max highlights some of the tools investors can use to protect themselves. Tim
Inflation can be a scary thing. It’s hard to know what will happen in the future, and inflation is often unpredictable. Imagine if your purchasing power were diminished by 50% in one year.
There are many ways that you can protect your money against it, whether by investing it wisely or planning for the rise in inflation with inflation-resistant assets that will be a hedge against inflation.
Investing can be a stressful concept in an inflationary environment since inflationary periods can cause your investment strategy to change rapidly. Having too much cash over long periods can be detrimental as well as investing in high “growth potential” options.
Which asset class should you invest in?
In this article, we’ll explore 15 different ways you can help protect your money from inflation.
How Does Inflation Affect Money?
Inflation affects money by decreasing its buying power. If inflation is at a rate of five percent per year, then your money will be able to buy 95% of what it could last year with that amount of money.
For example, if you were to spend $100 on something today and inflation was at five percent for the next twelve months, next year that same $100 would only buy goods priced at $95 because inflation caused prices to increase by five percent during this time period.
This means that even though your salary may not have changed since last year (as inflation rates are usually expressed as annualized), more than likely it won’t stretch as far in terms of purchasing items like food or clothes since those consumer prices have risen due to inflation. This higher inflation hurts millions of people in the middle class and those with a fixed income.
Why Inflation Is Called the “Worst Tax”
Higher inflation is called the “worst tax” because it not only affects your buying power but also the return on your investments.
Imagine inflation is at five percent per year and you’re able to put $100 in a savings account that pays interest of three percent annually (a pretty good rate). After one year, you’ll have earned one hundred dollars via interest.
However, inflation will cause prices for goods to increase by five percent so if inflation were still at five percent after this time period then it would cost you $105 next year to buy what costs $100 today due to inflation eroding your money’s value over time as it will push prices higher.
If inflation was to remain at five percent for a long period, your money would become completely useless since it wouldn’t be able to buy anything due to rising prices and the purchasing power not increasing relative to inflation.
What Happens When Inflation Rates Are Negative?
While inflation rates are usually positive (meaning they’re above zero), there can also be times when inflation is negative or below zero. This is called deflation.
This means that the general price level falls rather than rises over time which has its own set of issues such as lower economic growth and higher unemployment.
However, if the inflation rate were extremely low – close to zero – then it could actually benefit people by allowing them more purchasing power with their dollars even though prices are low.
Why Is It Important to Protect Your Money Against Inflation?
If inflation is high, then it’s important that you’re able to maintain the same purchasing power for your salary and also be able to invest enough of it so inflation doesn’t eat away at any earnings from interest on these investments.
Inflation rates are usually expressed as annualized percentages which means that they measure how much prices have increased or decreased over a one-year period.
Since inflation impacts our economy by impacting people’s lives, many central banks around the world try their best to avoid high inflation levels in order to avoid economic problems such as recessions.
If inflation is too high, this causes other issues like stagflation where unemployment increases along with price levels which makes inflation much harder to control.
This can cause serious problems for people since inflation rates are usually only expressed in annualized percentages which means that inflation may outpace your salary growth several times over a long period of time (meaning more of your money will be eaten up by inflation than earned through increases in earnings). Taking this into into account with your full personal finance picture is important.
If inflation is 5% for the year and you didn’t receive a raise last year at your job. You have less power to buy things today than you did last year. This is why buying inflation-protected assets is so important.
1. Gold and Other Tangible Assets
One of the most popular inflation-proof asset classes to invest is intangible assets like gold and silver. These metals cannot be printed by a government, they don’t rot over time, and they retain their value much more easily than other investments which can quickly lose their worth with inflation.
Gold is a good hedge against inflation. If inflation occurs, the value of gold will rise because people want to trade their devalued cash for something that won’t lose its worth like metal coins with intrinsic value. An asset class that cannot be created by government decree is usually a good hedge against rising inflation.
Another inflation hedge investment as inflation rises is in commodities. Commodities are essentially raw materials that have future value, so they will often rise when inflation occurs because the cost of production increases while simultaneously decreasing their supply.
Commodities include oil and gas for fuel, food like corn or soybeans to feed livestock, metals like copper or aluminum used by manufacturers to create other products, gold, and silver as discussed above, wood pulp for paper making which has uses across lots of industries, cotton fiber/linen fabric used by clothing makers, etc.
Most tangible things are used to power our health care systems, build real estate, and anything we eat as commodities. The investment returns on commodities can be substantial especially if prices tend to be rising and the overall counter-wide or global financial situation worsens.
3. 60/40 Stock/Bond Portfolio
60/40 is a well-known investment mix that includes 60% stocks and 40% bonds. It reduces inflation risk by including both inflation hedging assets like precious metals, commodities, etc. as well as treasury bonds which are often inflation-protected themselves.
This type of portfolio can be very low maintenance when an investor chooses to buy index funds instead of only investing in mutual funds because they will automatically track the market average for them without having to actively trade daily or weekly depending on whether you choose individual indexes or ETFs (exchange-traded funds).
4. Real Estate Investment Trusts (REITs)
Real Estate Investment Trusts are a type of security that holds investments in real estate property. They can be publicly traded on stock exchanges and will often pay dividends as well as offer inflation-protected rental income from tenants who have to continue paying rent even if inflation occurs because it’s the cost of doing business for them.
REITs do come with some risks though– what happens if there’s a natural disaster like an earthquake or hurricane which damages properties held by these REITs? Even the most prudent in risk tolerance cannot predict the forces of nature let alone external market forces.
This is why investors should diversify their portfolio with different asset classes too so they don’t lose everything when something unfortunate does occur, but also partially because you want different types of assets to protect against inflation since one alone can be extremely volatile over a decade or longer period of time. Best to know your risk tolerance and act accordingly.
5. S&P 500 ETF
An inflation-proof way to invest in stocks is through an S&P 500 ETF. The S&P 500 index consists of the biggest, most liquid companies on the American stock exchange and this type of fund will track their performance so you can expect inflation protection as long as they exist.
This includes inflation hedging assets like commodities since many large manufacturing firms are included in this index too along with other types of businesses that also see inflation increase costs over time.
The only drawback to investing in a general market ETF or mutual fund instead of individual stocks that hold REITs for example is diversification– what happens if all those stocks go down together? How much money will be lost if that happens?
6. Real Estate Income Through Renting Out A Home
Investing in a home to rent it out is inflation-protected because inflation will cause the cost of new construction and materials used by contractors to rise. We’ve definitely seen this before with property values.
Homeowners can reduce expenses by renting out their homes and put that extra money into something that can be a hedge against inflation. This side hustle and real estate, in general, is something I’ve been doing for years and important to a diversified portfolio.
This allows that rental income to be invested in inflation hedging assets like precious metals or long-term bonds.
7. Leveraged Loans
A leveraged loan is a type of asset-backed security that’s inflation-proof. These are typically used for commercial real estate investments and the interest rates will adjust according to inflation and are better than a fixed rate of interest.
This loan is typically given to a company that has significant debt already so be sure your investments are not heavily weighted in this category.
8. Treasury Inflation Protected Securities (TIPS)
An inflation-proof investment for those who want to invest in long-term inflation hedges instead of short-term ones is investing in treasury securities. These are bonds issued by the US treasury and will adjust their interest rates according to high inflation so you can be sure that inflation doesn’t eat away at your return on investment over time as it does with normal paper currency or savings accounts which earn little extra money over time because inflation takes its toll even if all other factors remain constant.
TIPS work best for people looking to have a hedge against an inflation portfolio.
Stocks are inflation-proof because high inflation will cause the price of goods to increase which means companies can charge more for their products.
However, this is only true if the company in question manufactures or provides a service that people still need when we are in an inflationary environment.
Putting too many resources into any single stock could be very risky but at least you’ll lose out on some returns during times of deflation since inflation-proof assets tend to rise faster than investments that don’t protect against inflation as stocks do.
Keep reading: Pros and Cons of Investing in Stocks
The inflation-proof nature of cryptocurrency works in the same way as stocks– inflation will cause prices to increase so companies can charge more for their goods which means people are willing to pay.
However, since cryptocurrencies are fairly new and not backed by anything at this point it’s better if they make up a small portion of your portfolio instead of trying to go all-in with one coin unless you have enough money lying around where losing some won’t hurt too much.
A lot of corporate investment portfolios have started to include crypto because let’s face it, inflation matters.
11. Short Term Bonds
Short-term inflation hedges like short-term bonds will adjust according to inflation so investors won’t lose out on money over time due to inflation eroding their savings.
The downside is that they don’t protect you against deflation which means if all other factors remain constant, your investment may not grow as quickly or at all even if inflation occurs since it’s too small of an amount invested for the contract terms.
Also, in the short term, you’ll want to make sure you have a fully-funded emergency fund even during inflationary periods.
12. High Yield Bonds
These are inflation hedges that adjust according to inflation through the same mechanism as short-term bonds. However, they’re riskier because you have to invest more money for a longer period of time.
13. International Bonds
The bond market and international bonds will adjust according to inflation which means inflation won’t eat away at your return on investment over time.
However, there is no deflation protection so you risk losing out completely if market factors drop faster than inflation does or all other factors remain constant and inflation occurs but doesn’t rise as high-interest rates rise on the bond. This can cause bond prices to fluctuate. This is why it’s best to keep different asset classes in your retirement accounts.
14. Review Debt Balances
I recommend not having any unsecured debt. Unsecured debt such as a credit card can really put you behind financially especially if you have a fixed income.
Secured debt, like that of an investment property can be an effective inflation hedge. The inflation protection you can receive by owning real estate is great even on a fixed income.
If you have a 30 year fixed mortgage and the consumer price index (inflation) is increasing you will be making the same payment each month on less expensive debt. That’s a win-win because a dollar today is worth a lot less than a dollar 30 years from now. This is one of those financial instruments that most people know about but not why it’s important.
Related: How I Use Debt To Build Wealth
Inflation hedges like equities will adjust according to inflation so investors won’t lose out on money over time due to inflation eroding their savings.
The catch is that they don’t protect you against deflation which means if all other factors remain constant, your investment may not grow as quickly or at all even if inflation occurs since it’s too small of an amount invested for the contract terms and what happens when there are no dividends being paid out because companies are just struggling financially instead?
There are all ways that can protect you against inflation.
Even though there is no way to avoid inflation completely, having a diverse investment portfolio of hard and soft assets helps hedge against different types of risks while also protecting against inflation.
You don’t want to be relying on a meager social security benefit when your money is losing value each and every year.
Investing in these assets will help you beat inflation and be in a better position financially.
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Tim Thomas has positions in the stocks, ETFs or commodities mentioned.
Featured Image Credit: Pixabay.