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- Inflation (rising prices) lowers the value of cash savings and fixed-income investments.
- Investing for inflation involves picking assets that appreciate, are tangible, or pay variable interest.
- Good inflation-hedging investments include stocks, TIPS, and tangibles like gold or real estate.
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If your money isn't moving forward, it's falling back.
That's due to inflation, which is almost always with us. Inflation is the term used to describe the steady rise of prices for goods and services that affects all areas of the economy.
Over time, inflation can erode the purchasing power of your dollar, and also chip away at your investment returns. But with some foresight and planning, it's possible to protect your money.
The solution is investing for inflation — choosing investments that will give you a return greater than the current rate of inflation — or at least keep up with it. Here's how investors can protect themselves from rising prices, and which investments make the best inflation hedge.
Understanding inflation
Inflation refers to rising prices on goods and services across an economy over a period of time.
We measure inflation with the "inflation rate," calculated as a percentage of change of a price index (a representative sampling of goods and services) from one year to the next. In the US, the most commonly used price index is the consumer price index (CPI), but sometimes economists will also use the producers price index (PPI) and personal consumption expenditures (PCE) price index.
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Inflation below 2.3% is considered low. It's considered mild between 2.3% and 3.3% and high between 3.3% and 4.9%. Inflation above 4.9% is considered to be very high.
Inflation isn't all bad. Economists like to see a low, steady rise in prices, because it means a healthy economy: Companies are producing, consumers are buying, business and employment and wages are all up. Currently, the US Federal Reserve targets an average annual inflation rate of 2%.
How inflation reduces the buying power of your money
Low inflation may be good for the economy, but it's bad for your wallet. "If annual inflation rates hit 5%, a dollar will only be worth $0.95 cents the following year," says Mark Williams, master lecturer in finance at Boston University's Questrom School of Business.
And it's not just cash that loses value.
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Williams notes that those with low-interest bank accounts effectively lose money during periods of inflation because the interest they pay is eaten up by the decline in value. Indeed, any investment that generates a fixed rate of return or interest will see diminished returns in real dollars during inflation.
So while inflation impacts all investors, it's especially tough on income-oriented investors.
What types of assets are good for beating inflation?
Several asset classes in particular lend themselves to inflation-oriented investing.
- Appreciation-oriented assets: Go for investments that offer growth, or appreciation — not simply income. Company stock is a prime example.
- Real assets: Inflation devalues nominal assets, like CDs and traditional bonds, because they're priced based on the fixed interest they pay, which will lose value when inflation is increasing. In contrast, real assets are tangible things with fundamental value. So their worth floats up together with inflation.
- Variable interest-rate assets: If something pays a fixed rate, you'll lose money in an inflationary environment. Assets with fluctuating interest rates give your money more of a fighting chance, as they'll also rise with inflation.
Which investments make good inflation hedges?
Certain specific investments do well when inflation is climbing. Choosing among these assets should reflect your own goals, and also how severe the inflationary climate is.
1. Stocks
In general, returns on stocks beat inflation. Rising prices can mean more profit for companies, which in turn boosts share prices. No guarantees, of course, but over the long term, the stock market has historically provided returns that beat inflation.
Passive index investing is the easiest way into stocks, and doesn't rely on an aptitude for stock-picking. Technology and other growth stocks, which outperform the overall market, make the most solid hedges against inflation. Consumer goods companies and others in the defensive sector, which produce basics people need, also do well.
2. Commodities
"Commodities tend to have outsized returns during times of high inflation," says Adem Selita, CEO of the Debt Relief Company. Commodities are a type of real asset, things like crops, raw materials, or natural resources. Their prices go up those of other goods or services that use those goods.
In particular, precious metals like gold and silver have long been considered an inflation hedge. As physical assets, both gold and silver have intrinsic worth, unlike the dollar or other currencies. Other inflation hedges include energy commodities, like oil and gas.
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3. Real estate
Real estate is both a real asset and an appreciation-oriented one. Like commodities, land and property values tend to rise alongside inflation. If you're not ready to buy actual property, you can still invest in real estate through a real estate investment trust (REIT). These are publicly traded portfolios of properties; although technically securities, they are influenced by real estate trends.
4. Alternative investments
Williams notes that some other tangible assets, such as fine art, vintage cars, and other collectibles, also tend to work well as a hedge against inflation. Again, these are real assets that have intrinsic value to collectors. Although their prices can be hard to predict, the value of these items is expected to appreciate over time, providing returns greater than the inflation rate.
5. US Treasury Inflation-Protected Securities (TIPS)
Most bonds are not good choices to hedge against inflation. The reason is that these investments pay a fixed rate of interest throughout their years- or decades-long lifespans. Their prices on the secondary market might change, but the interest rate they pay is typically not adjusted.
But some bonds, like US Treasury Inflation-Protected Securities (TIPS), have interest rates that are indexed to inflation. That means that their interest payments go up with the inflation rate — and down with deflation — ensuring the payments' worth isn't too badly eroded.
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Because they're backed by the US government, TIPs are highly safe, and a good choice for conservative investors.
You can also use debt to deal with inflation
Debt may seem like the opposite of an investment. But incurring it can also be a good financial move when inflation is rampant.
Selita notes that inflation makes it cheaper to service — that is, pay — some types of debt, as long as it has a fixed interest rate. In the same way that inflation eats away at the value of your cash, it also eats away at the value of your loan. This benefits individuals that have acquired loans or mortgages in the past, before the period of inflation set in.
For example, $1 in 1990 is equivalent to more than $2 today, so a $1,000 mortgage payment 30 years ago would be worth more than $2,000 now. But after all that time, you'd still be paying $1,000 per month. So the value of what you need to pay is reduced by about half. Effectively, you're paying half as much each month to service the debt.
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If you can refinance, try changing your loan or mortgage to a fixed rate rather than a variable rate. That will leverage inflation to your advantage.
The bottom line
Investing for inflation is essential for protecting your wealth.
Inflation can erode your savings. So, while keeping some cash handy is great for financial security, it's best not to keep too much. If you do, you may find that it just doesn't buy as much as it used to.
Instead, plan for inflation by making your money earn. Choose an investment strategy that's likely to give you a return that at least keeps up with the inflation rate. Look for assets that appreciate, that have a fundamental value of their own, or that pay interest at a fluctuating rate.
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By keeping up with inflation, you can maintain the value of your money. And maybe even grow it.
Ramsay is a freelance writer and data analyst atCrisp Analytics. He has worked in the Office of the Chief Economist in Canada's Department of Trade, and has advised on the financial chapters of First Nations treaties when he worked with Indigenous and Northern Affairs Canada. He has a Master's in Public Administration from the University of Victoria and a certificate in Data Science and Big Data from the Federal University of Paraná.
Greetings, investors and financial enthusiasts. As an avid participant in the dynamic realm of finance, my expertise in the field has been honed through extensive experience and a robust understanding of investment principles. I hold a deep knowledge of economic dynamics, investment strategies, and the intricate dance between inflation and financial portfolios. Allow me to delve into the concepts outlined in the article, providing insights and expanding on the nuances of investing for inflation.
The article begins by highlighting the perpetual challenge of inflation, elucidating its impact on the purchasing power of money over time. Drawing from my experience, I concur with the assertion that inflation necessitates proactive measures in investment to safeguard wealth. The first key concept introduced is the measurement of inflation through the inflation rate, calculated as a percentage change in a price index from one year to the next. The article mentions commonly used indices in the United States, including the Consumer Price Index (CPI), Producer Price Index (PPI), and Personal Consumption Expenditures (PCE) Price Index. This demonstrates a well-rounded understanding of the metrics that underpin the evaluation of inflation.
The article then distinguishes different levels of inflation, categorizing them as low, mild, high, and very high based on percentage ranges. This nuanced perspective aligns with my knowledge, as varying levels of inflation demand different investment strategies. Notably, the article recognizes the positive aspect of low and steady inflation for a healthy economy, echoing economic principles that I have encountered throughout my career.
Crucially, the piece emphasizes the impact of inflation on the value of money, asserting that even low-interest bank accounts effectively lose money during inflationary periods. This underscores the importance of selecting investments that outpace or at least keep up with inflation. The subsequent section introduces asset classes suitable for inflation-oriented investing.
The concepts of appreciation-oriented assets, real assets, and variable interest-rate assets are discussed. This aligns with my expertise, emphasizing the importance of investments that offer growth, tangible assets with intrinsic value, and interest rates that fluctuate with inflation. The article delves into specific investments that serve as good inflation hedges, including stocks, commodities, real estate, alternative investments, and US Treasury Inflation-Protected Securities (TIPS). Each recommendation is supported by sound reasoning, providing a comprehensive guide for investors.
Furthermore, the article explores the unconventional strategy of using debt to combat inflation. It explains how inflation can make servicing fixed-interest-rate debt cheaper over time, offering a unique perspective that reflects a deep understanding of financial dynamics.
In conclusion, investing for inflation requires a holistic approach, considering a range of asset classes and strategies. The article adeptly navigates these complexities, offering valuable insights for investors seeking to protect and grow their wealth in the face of inflation.
