Inflation is a B**ch: How to Hedge Against Inflation
If you’ve been anywhere near a computer or phone lately, you’ve probably heard about record inflation numbers. November 2021 saw inflation as high as 6.8%, a sharp increase from the 0-2% we’ve enjoyed for the last decade.
To put it in perspective, this is the highest inflation we’ve seen since 1982!
But what does this actually mean? Should you be concerned about these numbers? And most importantly: how does inflation impact your financial decisions?
That’s what this article is for. Let’s walk through some inflation basics, why they matter, and how you can hedge against inflation.
What is Inflation & How Does it Work?
When we look at the Oxford English Dictionary, we see that inflation means…
WAIT. Hold the phone!
Did you really think that we were really going to bore you to tears with charts, graphs, and a long explanation that would put you to sleep?
It’s true that inflation is a rather technical term and there’s a lot of economic theory behind it. But for our purposes, you need to remember just these two things:
- Inflation makes prices go up and the value of money go down
- Usually this is caused by one of three things: supply of goods went down, demand for those goods went up, or the cost of producing those goods go up
In fact, we can use the events of the COVID-19 pandemic to illustrate exactly why we’re experiencing inflation right now:
- The world practically shut down in 2020, meaning that we collectively put the brakes on how many things we were making (i.e. supply went down)
- As people came out of lockdowns before all the variants kicked back up, they started buying goods again with a vengeance (i.e. demand went up)
- Recent labor shortages means that companies have to pay more for the same work, making it more expensive to make things (i.e. cost of production goes up)
The fact that all three of these things are happening at the same time creates a perfect storm for inflation. Basically: thanks to COVID-19 and our response, prices are going up, which means your money doesn’t go as far as it used to.
Why Does Inflation Matter to You?
There are a number of reasons why you should care about inflation. The first and most obvious: as the costs of goods and services go up, your purchasing power goes down. Your salary may be the same or increasing, but if those increases aren’t keeping up with inflation, then you’re essentially getting a pay cut!
But inflation doesn’t just attack your salary. It also attacks your assets. Since inflation rates have remained between 0-2% over the past decade, investors have been more complacent about the threat of inflation. However, now that inflation has reared its ugly head again, it’s important that you consider it a real risk to your savings, retirement accounts, and other assets.
Not only does inflation cause uncertainty in the market, which impacts the growth of any investments you may have, it can seriously decrease the purchasing power of those assets. If you don’t have a plan to hedge against inflation, you should seriously consider one.
6 Options for Hedging Against Inflation
Here are some simple ways to protect your assets against inflation. However, it’s critical that you contact your own financial advisor to discuss the options that are best for you. We aren’t certified financial planners, and nothing listed below should be construed as official financial advice.
1. Real estate
When you finance a single-family home with a low, fixed-rate mortgage, you get two benefits. First, the home will appreciate in value, and this appreciation often outpaces inflation. Second, the cost to service the mortgage remains constant, insulating you from rising rent prices.
2. Value stocks
According to some research, value stocks tend to perform better than growth stocks during inflationary periods. Value stocks are companies that have strong earnings relative to their share price, which means investors typically value them higher when prices are rising.
Raw materials, natural resources, and precious metals like gold are always critical to production. As demand increases, prices on these goods rise, making them a safe-haven asset during uncertain times.
Treasury Inflation-Protected Securities (TIPS) are marketable U.S. Treasury securities aimed at combating purchasing power erosion through periodic inflation adjustments, which fixed-rate bonds do not have. Plus, TIPS are backed by the full faith and credit of the U.S. government.
Although you can only purchase $10,000 annually and they're considered non-marketable securities, I-bonds promise to keep pace with inflation. While they’ll never give you outsized returns, you will protect a portion of your portfolio.
Cryptocurrency’s limited supply should protect against inflation, making it a decent hedge. However, its volatility means that it shouldn’t be your sole hedge. Instead, make it a part of a diversified portfolio.
Final Thoughts: Investing for the Long Haul
One of the things to remember is that inflation, as scary as it is, is a short-term problem. Eventually, things will even out, and this will just be a blip on your decades-long investing journey.
That’s why it’s important to avoid making rash decisions:
- Develop an investment strategy based on your risk tolerance and financial goals and stick with it
- Don’t constantly change your strategy in response to the market; make small adjustments where needed
- Diversify your portfolio across multiple assets to avoid putting too many eggs in one basket
- Understand and limit costs like mutual fund fees
- Find a trusted certified financial planner to help guide you through these key decisions
When you stay focused on the long haul, you’ll find that inflation isn’t as scary as people make it out to be. Stay focused, keep on saving and investing, and make good choices.
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