Inflation is all about the cost of goods and measuring the impact of price increases at any given point in time. To properly diversify as an investor, one must understand inflation and how it impacts the economy.
The purchasing power of $5 20 years ago in 2000 now is the same as someone who has nearly $8 in their pocket to spend today. Over time, it costs more to buy the same goods. People need to be aware that their incomes need to either outpace inflation or at least keep the pace. If your income stays the same, you are not going to be able to afford the same goods later on that you are affording right now.
Inflation erodes value, and that statement is not just about currencies and the cost of goods. It has everything to do with the investments in your portfolio.
Inflation is real, and it is a problem. If your investment portfolio fails to outpace inflation, you might lose money overall. Many investors play it safe and choose guaranteed returns that outpace inflation, helping them to continue on their road to building wealth without the risk.
How do you hedge against inflation?
Individual investors must understand that hedging against inflation is not just about choosing investments. It is also about the state of the economy and the timeframe a person has to invest toward retirement. Commodities have long been considered to be a great choice for hedging against inflation, but are they? Some research supports the idea that gold is the best hedge against inflation.
Most economists, however, argue that traditional stocks are your best bet for the long haul. Are you starting to see why diversification is so important? While corporate earnings often outpace inflation in general, you never know what the state of the economy is going to be at any given time. The stock market has, however, historically outpaced inflation collectively and has risen on average 10 percent each year.
Is Gold The Missing Link?
Gold has always been touted as an investment to help people hedge against inflation. Gold has for centuries both held and increased its value over the long term. The same cannot be said about world currencies. Investors have long compared the spot price of gold to what you would pay for a new suit. In today’s world, that new suit would cost you around $1800. Back during the height of The Great Depression, that suit would have cost you $35.
Gold appreciates nicely against inflation, but that doesn’t mean it is the perfect hedge for your portfolio. Gold prices fluctuate based on other factors as well. One common myth, however, is that gold mining companies as well as supply and demand have a lot to do with the price of gold. These factors rarely have an impact on gold prices, as gold is in abundance and mostly seen as a store of value, a longstanding one.
What about Bitcoin?
In theory, Bitcoin and other cryptocurrencies appear to be a great hedge against inflation. Many investors are rushing to make crypto a part of their portfolios. While that is great, there is an inherent risk with crypto considering the newness of the market. Crypto is in its infancy. While holding some Bitcoin to hedge against inflation sounds like a plan, the strategy is not tried and true.
Investors have to remember that Bitcoin has only been around for a little over a decade. Additionally, inflation has not been full speed ahead in the last decade. It is difficult to say how Bitcoin would perform against inflation. It has its highs so far, and they are big highs, but its lows are big. It should be mentioned, however, that Bitcoin never dips below its previous low, so far. Crypto appears to have a promising future hedging against inflation.
When certain inflation rumors circulated earlier this year, stocks took a small tumble, but the crypto market fell apart. By the time all was said and done, BTC had lost 41 percent of its value.
What About Real Estate Vs Inflation?
Real estate has long been used as a haven for investors looking to hedge against inflation. Inflation drives the cost of goods and services, so that leads people to draw conclusions that such a movement involves real estate, too. History is on their side because property values tend to be on the rise when inflation is hyperactive. This means more rental income for investors, too.
Have you heard of the term depreciating debt (https://www.investopedia.com/terms/d/depreciation.asp)? Fixed mortgage amortization schedules are long-term and can find investors enjoying depreciating debt during periods of sustained hyperinflation. That makes real estate look like a really good investment over the long term if you are trying to hedge against inflation.
Natural Resources Vs Inflation
Commodities and natural resources are certainly sensitive to inflation, but do they perform the best when trying to hedge against inflation? Commodities are great for any portfolio, but they are not guaranteed protection against inflation. There are too many factors involved. This is why many investors are now looking at equity-based commodities.
What about TIPS?
TIPS is fairly new, and the data compiled would be skewed since these financial instruments have only been flexing their muscles since around the time of the 2008-2009 financial crisis. Analysts need more long-term data to help them gauge how TIPS securities perform against inflation.
TIPS securities are indeed indexed to inflation, but many factors can fluctuate their performance with what is going on with the economy. Still, TIPS is a strategical asset designed to tackle inflation for investors. The fixed-rate return is also on point. According to some analysts, TIPS and natural resources are an investor’s best bet when trying to hedge against inflation.
Other financial gurus, however, would argue that the market and gold are the way to go. Investors heavy into real estate would tout physical property. Your best bet is to have a portfolio full of various types of equities, including commodities equities, TIPS, traditional companies, etc. Hold real estate and gold as well. It is a 1,2,3 approach: Stocks, Real Estate, and gold. Do not forget to follow trends like crypto, too, that can outpace the economy in general, much less inflation. Diversification is your best hedge against inflation.