Today, what it costs today to buy a coke was what it cost thirty years ago for a hotdog and a drink. The exact amount seventy years ago would have given you a trip to the cinema accompanied by a drink and some popcorn. This is the result of inflation. As time goes by, inflation decreases the amount and value of goods one can purchase with the same amount of money.
Inflation occurs simultaneously with periods of economic growth. Most economists believe inflation is inevitable, and a healthy range is 2-3% annually. However, the current economic recovery is seeing over 5% inflation. This is considered high and will have a negative effect on living conditions if the situation is prolonged.
This article will discover investment options that will best protect the worth of your investment portfolio and purchasing power in periods of high inflation.
Inflation is a measure of the increase in price levels of specific baskets of goods in an economy. This diminishes the purchasing power of consumers. High prices mean that the same amount of goods will cost more money.
The two ways the price level of an economy can increase are: decrease in aggregate supply (cost-push inflation) or increase in aggregate demand (demand-pull inflation).
Real estate is a good investment to make when the rate of inflation is high. It is a hot prospect at the moment as the prices of housing markets around the world are increasing exponentially. Many markets in Asia have observed 100% growth in the last five years. With fast growth, the housing market is one of the few that has the potential to grow faster than inflation.
Investment in real estate also yields passive income. You can rent your property, and the rents that tenants pay will increase according to inflation. Therefore, not only will you receive gains from the property, rental income is a good source of inflation-adjusted income.
However, real estate investments are not straightforward. It requires a lot of paperwork and legal procedures. Furthermore, this investment requires a higher initial capital than other investment methods. Selling real estate is also possibly an arduous process. Hence, it is most suitable for wealthier investors who do not require quick access to their invested money.
When prices are uncertain, it is a good idea to own some physical assets. The most popular option is gold, but other precious metals are also good investments. Investing in commodities gives investors the flexibility to transfer easily into an alternative currency if there is a problem with their current currency, such as hyperinflation.
Commodities also include primary materials. This will be an indication of the prices of products that are produced from them. Thus, they are a good indicator of inflation. Owning commodities helps investors keep a hand on the pulse of inflationary trends, assisting them in making better decisions.
Although the entry capital might be lower than real estate, commodity investment does come with some risk. Investors can trade commodities on the futures market, which is quite volatile. Commodities are also volatile because they depend on the relationship between demand and supply. Small changes in trade, economic or political conflict can cause a momentous change in price.
Stocks are fundamentally a similar investment to real estate during inflation. Investors benefit from capital gains and passive income. Focus on stocks that have a high potential for growth that can outperform the rate of inflation. According to Warren Buffet, businesses that have low capital needs will likely thrive under these circumstances. Preferably, these businesses should be somewhat essential and have the ability to raise their prices.
Finding stocks that yield dividends is not as important. In fact, it is not preferable because the payout is similar to that of a fixed-rate bond. The real value of dividends will be decreased.
Stocks do have a tendency to be a risky investment during periods of high inflation. If firms are unable to raise their prices or keep prices low enough to have sufficient demand, they might be at threat of closing down. Investing in a losing stock might cost investors’ their whole committed capital.
Treasury Inflation-Protected Security (TIPS)
Another method recommended by Warren Buffet, TIPS, is a good tool to protect investors against inflation. The mechanics are similar to a bond, where investors are paid two times a year. Their total capital will be adjusted for inflation.
For example, with an initial investment of $100, if the inflation rate is 4% and the interest rate is 3%, the initial capital will be adjusted for inflation first to be $104. Then the 3% interest rate will be applied on top of that.
Nevertheless, this is not the perfect solution. Firstly, it is a long-term commitment. There are three tenures: 5 years, ten years, and 30 years; hence, it is not a suitable investment if you are looking for short-term methods to avoid certain inflationary periods. The yield of this is not very lofty compared to other methods of investments. Lastly, if there are deflationary periods, investors’ capital will be adjusted in the opposite direction.
Periods of inflation can be unsettling and skims off parts of our investment portfolio. There are different investment methods to combat this, ranging from high risk, high reward real estate investment to high safety in TIPS. Focus on investments that have a higher yield than the inflation rate, and stay away from fixed-rate dividends. Whatever method you choose, do not leave your money idle, as that is the only sure way of losing purchasing power.