Updated: Oct 29, 2021
With trillions of dollars of COVID-19 stimulus introduced into the economy, many economists have forecast the possibility of increased inflation. The cost of goods and services has already risen, with the Consumer Price Index (CPI) rising 5.0 percent from May 2020 to May 2021. Furthermore, CPI doesn't even consider the cost of purchasing and maintaining a home.
Inflation can devalue your retirement savings and assets significantly, but the dollar depreciation of inflation does not affect all investments equally. Some often perform better than others in times of heightened inflation. Moving forward, you should keep the investment fundamentals below in mind as you work to safeguard your portfolio against potential inflation in the near future.
What is Inflation?
By definition, inflation is a rise in the price of goods and services. It's usually calculated using the Customer Price Index, which measures the costs of numerous items that a consumer could buy. Inflation may raise the cost of just about anything, from your clothing to your oil change. Furthermore, salaries, unfortunately, do not always rise in synch with inflation. This means that your income may buy you less and less over time. As a result, inflation can also be thought of as a loss of purchasing power.
Inflation, on the other hand, isn't always a negative thing. Although it varies throughout time, many experts believe that approximately 2% inflation per year is a sign of a healthy economy. As a result, the Federal Reserve intends to maintain a long-term inflation rate of 2%. For much of the recent past, inflation has been below that objective, and the Federal Reserve has stated that it will allow inflation to climb to over 2% in the short term to level things out, which means we should prepare to deal with this rise.
Real Estate Asset Protection
Some things have intrinsic worth, meaning the underlying value remains relatively consistent. Real estate is one of those things. People need a roof over their heads, so they are willing to pay the current rate. Here are some ways that you as an investor can take advantage of real estate’s inflation hedge:
Rental Properties: Rental properties provide continuous benefits such as passive income, tax advantages, and the opportunity to borrow money from others. One of the benefits that are sometimes overlooked is the built-in inflation protection. As a landlord, you raise the rent every year to keep up with market pricing, which typically paces inflation.
Buy a Home: Homeowners with fixed-interest mortgages are shielded from inflation, at least for the initial expenditure. Home prices tend to rise with higher inflation, but a fixed mortgage payment will become easier to manage with higher wages. Renters are not protected in the same way. They may anticipate rent to grow each year in unison with inflation, if not faster. However, don't confuse your property with a genuine investment. Housing is a necessity, not a financial investment. You spend money on taxes, maintenance, and more with a home purchase. Keep this in mind when you are deciding how much to spend on your home. A true investment should earn you money and not create ongoing liabilities.
Real Estate Investment Trusts: Real estate investment trusts (REITs) are investment funds that invest in real estate, either directly or indirectly. Even though REITs are paper assets, real estate secures them, and their profits are linked to real estate prices and rentals. This provides them with a degree of inflation protection that may be comparable to direct real estate ownership but with considerably greater liquidity.
Keep in mind that no investment is entirely inflation-proof as you look at inflation-resistant options. These assets have traditionally outperformed greater inflation, but that doesn't imply you'll be immune to price volatility due to inflation.
Material things with intrinsic worth are referred to as commodities. Metals like copper, energy like crude oil and natural gas, gold, and timber, as well as food essentials like grain, sugar, and coffee, are among them. People desire and need them in their daily lives, which keeps demand reasonably steady. So, regardless of the currency, they sell in or the value of that currency, their price changes depending on supply and demand market realities. When the value of the dollar falls, the cost of these necessities generally rises to compensate.
Because you're unlikely to keep actual copper sheets or grain barrels in your shed, you may want to invest in commodities using funds in your brokerage account. You may purchase mutual funds or ETFs to gain exposure to the commodities markets.
Treasury Inflation-Protected Securities
Physical or actual assets aren't the only investments that can withstand inflation. The Treasury Department offers a sort of bond that is specifically designed to safeguard against inflation. TIPS, or Treasury inflation-protected securities, adjust in value in unison with inflation. They pay a set interest rate and maybe bought and sold on the open market, just like conventional bonds. However, unlike regular bonds, the principal amount fluctuates with inflation. Let's say you invest $1,000 in a TIPS bond that pays 6% annual interest, or $60 each year. Ordinarily, if inflation rises to 9%, a 6 percent interest bond would lose real purchasing value. On the other hand, TIPS increases the principal amount of your bond and pays your interest on that amount. TIPS mature and pay you the new principal amount as the face value rather than the amount you paid when they were purchased. Given the extra safeguards and support of the US Treasury Department, they tend to pay exceptionally low-interest rates. But, at the very least, they shield you against inflation.
Companies that can raise prices in tandem with inflation have a better chance of surviving inflationary conditions. Even if food firms' raw material and supply chain prices rise due to inflation, they can usually pass those increases on to their customers without suffering any negative consequences. Many industries that offer critical services follow the same rationale. People pay the market rate for necessary things, just as they do for commodities, even if inflation causes prices to rise as the value of each dollar decreases. Food, health care, energy, and building materials are examples of industries that generally do well during inflationary periods. As long as these firms can retain profit margins while raising prices in line with inflation, their stock price may grow in synch with inflation.
Variable Debts to Fixed Interest Debts
During periods of high inflation, the federal government often raises interest rates to slow it. Because lenders lose money if interest rates do not keep up with inflation, this helps keep the financial system viable. Borrowers with adjustable interest rates might expect their rates to rise if hyperinflation develops. On the other hand, borrowers with fixed interest rates rejoice because the value of their loan payment falls as the value of the dollar declines. If you're concerned about inflation, you might want to consider refinancing your adjustable-rate debts to fixed-rate debts.
Get A Consult With an Experienced Financial Advisor
The idea of potential inflation can be problematic, and that’s why our experienced advisors are here to help you. At Fourth Avenue Financial, our first priority is your overall financial success. We want to help you develop, implement, and monitor a strategy designed to address your individual situation to ensure all your investments are setting you up for a path of financial success. If you are ready to start planning for your financial future, we are here to help. Contact us today at (304) 746 7977 to schedule a meeting with one of our experienced financial advisors or schedule online: https://calendly.com/fourthavenuefinancial/introductory-zoom.
Securities offered through J.W. Cole Financial, Inc. (JWC) Member FINRA / SIPC. Advisory Services offered through J.W. Cole Advisors, Inc. (JWCA). Fourth Avenue Financial and JWC/ JWCA are unaffiliated entities. This is for informational purposes only.