- Inflation is a hot topic. Should you be worried?
Regardless of any real consensus on how concerned the general population should or shouldn’t be about it, some economists will still panic at the sound of this word.
Considerably, there is no better way to understand the inevitable and unavoidable inflation than to learn to recognize it and, of course, to tackle it straight on. By doing so, you will find that it certainly isn’t the harbinger of doom many make it out to be.
Recognizing inflation: a brief introduction
Inflation works as a measurement of the average prices of goods and services in an economy. It is the reason why when you look at the CPI (Consumer Price Index) you will without a doubt find that has been a general rise in prices.
To put it in quite simple terms, things got more expensive over time and inflation is the reason you will often hear that “money doesn’t go as far as it used to”.
As such, it is a reasonable assumption that any amount of money that you are holding will very certainly not retain the same purchasing power over time and will obviously start hemorrhaging its value, especially when facing the combination of government stimulus and an unprecedented amount savings which may or may not be unleashed into the economy.
What to look for: higher prices in baskets of goods and services (CPI) due to a demand-pull or cost-push effect, and/or any major increases in the supply of money
Our tip: there are three things to account for which are often overlooked:
1.When extrapolating CPI data remember to take the pandemic into consideration and compensate your analysis by crosschecking it with the PCE (Personal Consumption Expenditure). This will get you a better picture of the economy on a macro level as the PCE will also give you a look into what businesses are selling.
2.The COVID-19 worldwide pandemic has skewed demand in an unprecedented way. Given the long confinements and quarantine periods, consumer demand changed and explored different avenues. In addition to a skewed demand, some businesses were not able to make it and were forced to shut down. The combination of the CPI and the PCE will give you more better look at things such as the replacement of goods.
3.The expectation of the very thing itself also matters. As people and business cling onto the idea that inflation is coming, their behavior, pricing and spending will certainly change with it.
Planning ahead: 5 ways to hedge inflation
When dealing with inflation, it is fundamental to understand money is not the only store of value and if an inflationary period is to be expected, investment is best made in assets which have a track record of outperforming the market during similar periods. The most frequent choices are gold, commodities, Treasury Inflated Protected Securities (TIPS) and real estate.
There is still an ongoing and longstanding debate on where it can be found and why and, despite inflation being a natural occurrence, it should not be an unexpected one if you are a disciplined investor.
Knowing the signals of an impending inflation period is half the battle. The other half being, creating a sound, inflation proof portfolio. These 5 simple solutions may be of great help.
1.Gold:
Often regarded as a safe-haven asset, gold prices rise during periods of high inflation or financial uncertainty which, to no surprise, makes it the preferred investment in these times of trouble.
Buying actual gold is an option but there are several things to consider such as storage and the actual logistics behind it.
2.Commodities:
Considered by many to be the leading indicators of inflation, commodities are quick to respond to economy-wide shocks to demand as they provide a clear signal about the global balances between the supply and demand sides.
The way this works is simple: when expecting high demand for goods and services, the price of said things is bound to rise, which, in turn, will also increase the price of the commodities used to produce them.
This makes them prone to be used as investors will seek downside protection to their capital and, of course, any upside potential they can take during these periods.
So how exactly does one start investing in commodities?
Direct investment is possible, but it might be unorthodox (or even unfeasible) for the average investor.
A wiser approach would be buying stock in companies which produce them or to invest in specific Exchange-traded Funds (or ETFs) which focus on them.
3.Treasury Inflated Protected Securities (TIPS) and Series I Bonds:
Treasury Inflated Protected Securities, or TIPS for short, have the benefit of paying a fixed interest rate which means that, as inflation increases, so does the value of the bond. This type of investment will perform well during inflation periods because of how they are designed to be indexed to the inflation rate. Other than that, will probably be lackluster.
As for Series I Bonds, the same goes, except they have a fixed return component which is indexed to the CPI but will also feature a variable one.
The Treasury Department’s Savings Bond Calculator will give you a better perspective on these.
4.Real Estate Investment Trusts (REITS)
REITS are essentially a pool of companies which own or operate with real estate. Since property prices and rental income are bound to raise during inflation, having a stake in these or a related ETF should be worthy of consideration.
5.The S&P 500
A long-term value play which is often overlooked.
One of the ways (if not the best) to prepare for bad periods in the stock market is simply to stay invested for the long-term.
Consequently, low return periods will not be of too much trouble as you will be in it for the long haul.
With the S&P 500, you will be investing into established companies, most of them with business models which require very little capital.
By doing so, you will offset any period of low returns by being invested with a much larger time frame and thus focusing on a longer period and high returns.