Inflation is a phenomenon well known to economists and financial analysts. It tends to be rather cyclical in nature. Inflation has a habit of resurging after periods of stagnation. It is important not to hit the panic button as soon as inflation starts to appear. Disciplined investors can start planing for it. How? By cultivating their awareness of asset classes that do well in inflationary circumstances. Indeed, some assets perform better than others during periods of inflation. While no asset beats inflation 100% of the time, some perform better than others. Inflation is less dramatic than a stock market crash, but it can be more devastating for your portfolio. Below we have listed the nine principles to follow in order to protect yourself.
Invest in gold
According to some studies, gold only beats inflation 54% of the time. But it remains a safe haven nonetheless. And for good reason – gold provides security to its owners. Indeed, it is cushioned against the vagaries of stock market prices, wars or inflation. There are therefore significant advantages to gold. It is still and will always be the best investment for security.
Invest in commodities
Commodities are a broad category, which includes grains, precious metals, electricity, petroleum, natural gas, etc. However, commodities can be a difficult asset class to invest in. There are different ways of doing it. Futures are one option, but they come with a great deal of risk and the possibility of complete loss. Exchange Traded Funds (ETFs) are more secure. Be careful though – when you invest in an ETF in order to gain exposure to commodities, the change in the price of the ETF’s value may not match the change in the price of the commodities themselves. This is due to the technical details of how the futures and commodities markets work.
There are other investments that may provide protection against inflation. Let’s take the example of companies that produce natural resources. These companies may be in the energy or metals sector. By buying shares in commodity producers, you may be able to take advantage of the protection they offer against commodity inflation, plus you own a company that is actually producing something, and so is likely to make a profit. Thus, commodities beat inflation 66% of the time. These are therefore rather safe investments that enable you to mitigate inflation.
Invest in real estate
Trading or investing in real estate beats inflation 69% of the time. Real estate can therefore provide excellent hedging against inflation. Over time, depending on what part of the country you live in, you may have noticed that house prices have increased dramatically since the 1970s, 1980s, 1990s and so on.
Over time, real estate prices have tended to increase most often in line with the rate of inflation. In some areas, the price is even increasing at a pace that exceeds inflation. Also, if you own a rental property, you will be able to achieve higher rents in an inflationary environment. This ability to increase your future cash flow provides you with a hedge against inflation if your cost of living increases proportionately.
Like land, house prices tend to increase in value year after year on average. It is true that real estate bubbles are usually followed by correctional periods, sometimes resulting in the loss of more than half of their value. However, on average, house prices tend to increase over time, neutralizing the effects of inflation.
Invest in shares
Shares offer the most potential for upward movement. Interestingly, the S&P 500 beats inflation 70% of the time. Most people express a lack of confidence in shares. However, owning certain shares can be a very good way to combat inflation. Invest in shares of commodity companies.
Products like petroleum, grains and metals enjoy price-setting power during times of inflation. The prices of these essentials tend to increase, unlike the price of a computer, which is subject to price adjustments (manufacturers and distributors). Finally, never underestimate the value of dividends in times of inflation. Dividends increase the total return of a portfolio.
Invest in bonds
Many investors, especially as they approach retirement, want bonds in their portfolios. Bonds provide the anchor and the stability of a diversified portfolio. For example, if you invest $100,000 in bonds and receive $5,000 a year in income, that might be a good return today. And that will be helpful for your retirement goals. With bonds, this income is often fixed. So how can this be mitigated in the event of inflation?
First off, you can focus on short-term bonds. By focusing on short-term bonds, you reduce your exposure to future inflation.
Plus, when these bonds mature, you can buy new ones. What happens when inflation rises is that interest rates also tend to increase.
Finally, in the bond sector, certain more aggressive types of bonds, such as high-yield bonds, emerging market bonds, etc., may offer better protection against future inflation. The yield or income generated by a high-yield bond is higher than that of other bonds. As the name suggests, a high-yield bond offers higher income, but also carries greater risk. Remember that the role of bonds in a diversified portfolio is to protect the portfolio.
Create a 60/40 shares/bonds portfolio
A 60/40 shares/bonds portfolio beats inflation 69% of the time. You can do work of distributing the portfolio yourself. Alternatively, you can call on the services of an investment advisor to build such a portfolio.
Invest in Treasury securities
Treasury securities are protected against inflation because they are indexed to inflation explicitly in order to protect investors. As a result, these securities beat inflation 80% of the time. They are some of the safest securities in the world because they are issued by governments. Indeed, there is no risk that the government will not be able to pay its bills. Even better, Treasury securities have an inflation rider, which adjusts the value of your capital as well as the consumer price index.
So if you want pure protection against inflation and any risk of credit default, you should consider including this type of investment in your portfolio.
Pay attention to your expenses
Another way to protect yourself against inflation does not involve your investments as such. Instead, it focuses on your expenses. The great danger of inflation is that the money you have to spend each month increases. To counteract this, you can limit your expenses. For example, if you have a mortgage, consider taking it at a fixed rate. One way to protect yourself against inflation is to set a fixed interest rate on your liabilities. This means you are no longer subject to the expenses increasing. If your loan is fixed, you know for sure what your future expenses are, regardless of the inflationary environment.
Invest in yourself
By far the best investment you can make to prepare for an uncertain financial future is to invest in yourself. It is the one thing that will increase your future earning capacity. This investment begins with a high-quality education, and it continues with updating your skills and learning new skills. It is your knowledge of the market that will enable you to bounce back most of the time in the event of inflation.
Conclusion to this article on how to protect yourself against inflation:
We probably won’t see soaring inflation in the next several years. But keep these asset classes on your watch list, then strike when you see inflation starting to emerge. This can help your portfolio to thrive when inflation hits. Visit us on Instagram or Facebook and join our #ProfitableTraders community
Start & Increase Your Income Using Financial Markets
Get proven processes, join a community of Profitable Traders and cash in your first winnings.