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The value of the dollar is steadily fading as time goes on. $100 in 1980 is equivalent to $335 in 2020. That’s a loss of 235% of purchasing power over the last 40 years.
The thought of inflation eating away at your hard-earned money is unsettling. Luckily, there are ways to protect your wealth, but they’re more complex than putting your money in a savings account.
Investments come with risk, and poor investment management can damage your capital worse than inflation. Investment risk is why people let their money slowly die in bank accounts. However, with proper research and diversification, you can protect and grow your wealth.
What is Inflation?
The US and most countries are in an inflationary environment. The price of goods and services increase while the purchasing power of currencies decline. Fiat money is designed to become inflated overtime to encourage consumption and increase economic activity. It’s a relatively controversial subject.
The opposite of inflation is deflation. With deflation, prices decrease, and the purchasing power of fiat increases. An increase in purchasing power sounds desirable, but deflation can have catastrophic economic consequences in today’s macro environment.
What Causes Inflation?
Prices increase when demand outweighs supply. If manufactures cannot keep up with demand, there will be fewer products for sell which naturally increases the cost.
Central banks purposely increase inflation by lowering interest rates, purchasing treasuries, printing currency, and more. These actions increase the money supply. When there is a high supply of money and a low supply of goods, prices inflate.
Investments That Protect Against Inflation
There are several ways to protect yourself from inflation and preserve your wealth. Some investments offer better inflation protection than others, but performance can vary. Below are eight different assets that can help you hedge against the invisible tax.
Physical Real Estate
Owning real estate, either as a personal residence or an investment property, helps guard against inflation. As prices increase, homebuilding costs rise, and the value of homes goes up.
Houses, commercial properties, and other real estate have increased substantially over the years and have shown to be an effective hedge against inflation. Owning your home and trying to sell it when prices increase can be tricky, because you’ll need to find a place to live.
Real Estate Investment Trusts or REITs are funds that can be purchased on the stock market. These trusts are companies that own real estate, from hospitals to hotels and more. As real estate prices rise, the companies valuation often rises as well.
Buying shares of REITs is an easy way to invest in real estate with less capital than purchasing physical properties. The share price can appreciate, and dividends are paid out to investors regularly. Be sure to research the company, as not all REITs are the same.
Treasury Inflation-Protected Security or TIPS are Treasury bonds created to follow an inflationary gauge. The financial instrument is designed to rise along with inflation to protect investors against fiat devaluation.
Interest is paid to investors every six months and is a fixed rate set at the bond’s auction. TIPS are low-risk investments because the US government backs them. The rate of return is low as well. Popular TIPS ETFs include iShares Tips Bond ETF (TIP), Schwab US Tips ETF (SCHP), and Vanguard Short-Term Inflation-Protected Securities ETF (VTIP).
Stocks can produce great returns during inflation, depending on which stocks you invest in. Mainly value and dividend stocks perform better, and growth stocks tend to underperform.
Historically, there are conflicting results on overall stock market performance during times of high inflation.
In most cases, value stocks with solid fundamentals have the best performance. Dividend stocks initially decline in price as the dividend isn’t enough to keep up with inflation. With a lower share price, investors can capitalize on higher dividend yields, producing higher returns in the long term.
Gold and precious metals like silver have been a go-to inflation hedge for years. As the purchasing power of the dollar declines, the value of gold rises.
Gold produces stable returns and has proven to be an effective long-term way to protect your wealth from inflation. Investors can purchase shares of gold mining companies, gold ETFs or opt to buy physical gold bullion.
Commodities are goods and raw materials like lumber, coffee, copper, oil, corn, and more. Inflation increases the price of commodities, making them a good investment during periods of high inflation.
Commodity prices have heavy fluctuations and can be riskier than investing in the stock market. The most common way to invest in commodities is through futures contracts. You can also invest in commodity stocks, ETFs or buy physical commodities like gold or silver.
Cryptocurrency is a new and very speculative asset. There is still a lot to be proven in the crypto world, but the returns and philosophy are worth noting. Bitcoin, Ethereum, and other cryptos have increased in price significantly while the dollar has declined.
Owning decentralized cryptocurrencies and utility tokens can prove to be an effective way to protect your wealth. The volatility makes it a very high-risk investment, but allocating a small percentage into crypto could be a wise choice. Crypto brokerages like Binance and Coinbase make it simple to invest.
When inflation runs high, the value of nearly everything goes up as the purchasing power of the dollar deteriorates. Alternative investments like collectibles, art, antiques, watches and more make for an interesting inflation hedge.
The rising costs of labor and raw materials make physical assets of all kinds more desirable. The collectibles market tends to surge alongside inflation and makes for an exciting way to diversify and protect your wealth.
Holding cash allows you to be ready for buying opportunities but can quickly get eaten away by inflation.
Inflation isn’t always easy to gauge, but the rising costs over the last decade are very apparent. Central banks have had loose monetary policies that are now seemingly impossible to reverse. Even the best economists cannot accurately forecast the future and each inflationary cycle is different.
The current macroeconomic environment significantly affects which investments will perform the best. Before making any investment, do your research and diversify.