How to Invest During Inflation
Investing during inflation may seem scary, but people tend to turn to a few trusted assets during these periods of the economic cycle. However, make sure you understand and are comfortable with the risk level of those investments as things can take a turn for the worse in any sector.
Real Estate
As inflation rises, the price of real estate usually rises with it. Having real estate investments in your portfolio can be an excellent way to protect yourself throughout inflationary periods. Furthermore, if you are already making a passive income from renting out your real estate investment, this income may increase as inflation increases because your mortgage payments will stay the same, but as inflation increases you can also increase your rate for rent. Generally, investors like to turn to tangible assets as protection against inflation as they are more likely to hold value and withstand worsening economic conditions.
Commodities
Investing in commodities is also another strategy investors use as inflation continues to creep up. The value of commodities moves linearly to the rate of inflation. This means that as inflation increases, so does the value of commodities. Commodities are defined as raw materials used in the manufacturing of other goods and services.
When inflation rises, the demand for goods and services also usually increases. This in turn will raise the value of commodities that are required to produce those goods and services. If your portfolio is equity heavy, adding a few investments in commodities can help outweigh the negative effects of inflation as they are inversely correlated.
Inflation-Indexed Bonds
Inflation-indexed bonds or Treasury Inflation-Protected Securities (TIPS) are one of the safest investments you can make to avoid the negative effects of inflation. These bond’s interest rates and principal are indexed to the rate of inflation.
This means that unlike typical bonds that lose value as inflation increases, inflation-indexed bonds will actually increase in value at the same rate of inflation. It is important to note that given the low risk nature of these bonds, inflation-indexed bonds will generally be more expensive and have lower yields.
Certain Stocks
During inflation, certain sectors of the stock market tend to outperform the others. These sectors include energy, oil, gas, utilities and healthcare. Stocks usually have the most upside potential long term; however, with higher upside potential comes higher risk. However, unlike the other options on this list, stocks are much quicker to obtain and get rid of and are less capital intensive. These features make them a good option for those with less buying power and higher risk tolerance.
If you want to invest in these sectors of stocks but don’t feel comfortable with the risk, consider investing in exchange-traded funds (ETFs) or index funds related to the energy or utilities sector. ETFs and index funds like the S&P 500 increase diversification and make it easier and somewhat less risky to invest.
Precious Metals
Following the trend of investing in tangible assets, precious metals like gold are another way investors have historically tried to protect themselves from inflation. It is acknowledged that the price of gold tends to move inversely with the buying power of a dollar. This means that as inflation rises, so should the price and value of gold.
Gold also is known as a 「safe asset」 meaning that it has a limited supply but is expected to hold its value during adverse economic conditions. Gold has historically been one of the most popular inflation-protected investments.
What is Inflation?
Economically thinking, inflation is the increase in price of goods and services. As a result of increased prices, the buying power of currency decreases. Therefore, inflation is inversely correlated with the purchasing power of money as when inflation goes up, purchasing power goes down. Overall, inflation is representative of an economic slowdown.
What Causes Inflation?
Inflation can be caused by many different factors. The main factors causing inflation include demand pull, cost push and expanding money supply.
A demand pull is defined as when the demand for goods increases at a rate suppliers can’t keep up with
Cost push is when production prices increase the price of goods and services
An expanding money supply is when the supply of money is greater than the amount of goods and services available
Right now in 2022, the main causes of inflation are supply shortages causing a cost push, increasing consumer demand causing a demand pull and the economic recovery from COVID-19.
When you Should Make Inflation-Informed Investments
Inflation-informed investments are a good idea. Whether inflation is occurring or not, having these investments in your portfolio can help keep you diversified and protected. The more proactive you are with investments the better off you will be. For example, stocks and other equities tend to drop in price when inflation is nearing, meaning you may be able to get them at a natural discount. On the other hand, real estate investments could be better off being made prior to inflationary periods as the initial investment you have to make will be lower.