Inflation is often thought of as a bad thing, but for investors, it can present opportunities. When inflation occurs, it means that the purchasing power of each dollar decreases. That might not sound like a good thing, but for investors, it can be an opportunity to buy assets that will hold their value or even increase in value as the cost of living goes up.
What Is Inflation and How Does It Affect Investors?
Inflation is an economic concept that refers to the overall increase in prices for goods and services in an economy. From an investing perspective, inflation can have a major impact on returns, which is why it's important to understand how it works. Here's a brief overview of inflation and its effect on investing.
How Inflation Works
In general, inflation happens when there's too much money chasing too few goods. This excess demand leads to businesses raising prices in order to try and profit from the situation. As prices increase, the purchasing power of each unit of currency decreases, which is what we refer to as inflation.
There are a number of factors that can lead to inflationary pressures in an economy, including things like strong economic growth, high levels of government spending, or supply shocks (e.g., increases in the price of crude oil).
Inflation and Investing
Inflation can have a major impact on investors, both in terms of the returns they earn on their investments and the real value of their portfolios.
For instance, let's say you invested $10,000 in a stock that paid an annual dividend of $500. If inflation was running at 3%, then the real value of your dividend would be $485 ($500 - 3%), which means your portfolio would only be growing by 2.85% per year in real terms.
Similarly, if you're investing for retirement, then you need to be aware of how inflation will erode the purchasing power of your nest egg over time.
For example, if you have a retirement portfolio worth $1 million that's earning an annual return of 6%, then you'll need roughly $1.6 million 25 years from now just to keep up with inflation (assuming a 3% rate of inflation).
How Does Inflation Affect Your Portfolio?
Not all investments will be affected by inflation in the same way. For example, bonds typically don't do well when inflation is high because the interest payments on bonds don't usually keep pace with rising prices. On the other hand, stocks tend to do well when inflation is rising because companies can pass along higher costs to consumers through price increases. This means that it's important to have a mix of both stocks and bonds in your portfolio so that you can weather any type of market conditions.
As these examples illustrate, it's important for investors to keep inflation in mind when making investment decisions. While there are ways to protect yourself from inflation (such as investing in stocks that tend to do well during periods of high inflation), it's still something that needs to be taken into account when planning for the future.
There are a few different ways to measure inflation, but the most common method is to look at the consumer price index (CPI). The CPI measures the prices of a basket of goods and services that are commonly purchased by consumers. The U.S. Bureau of Labor Statistics releases the CPI on a monthly basis.
Inflation can have a big impact on your investments, which is why it's important to keep tabs on it as an investor. The best way to track inflation is by looking at the consumer price index (CPI), which measures the prices of a basket of goods and services that are commonly purchased by consumers. You can find the CPI data on the U.S. Bureau of Labor Statistics website. Keep in mind that not all investments will be affected by inflation in the same way—for example, bonds typically don't do well when inflation is high—so it's important to have a mix of both stocks and bonds in your portfolio.
In order to take advantage of these opportunities, though, you need to know what types of investments will do well during periods of inflation. Keep reading to learn about some of the best investments to make during inflationary periods.
Protect Your Finances from inflation with These Tips
Review your expenses and make adjustments as needed.
Inflation can have a big impact on your budget, so it’s important to periodically review your spending and make changes as needed. Look for ways to trim your expenses without compromising your lifestyle. For example, you may want to switch to a less expensive cellphone plan or eat out less often. If you have discretionary income, consider investing in assets such as gold or real estate that tend to hold their value during periods of inflation.
Invest in index funds
Index funds offer diversification and tend to outperform actively managed mutual funds over the long term. While stocks are subject to market volatility, over time they have tended to produce returns that outpace inflation. In fact, since 1926, the stock market has averaged an annual return of 10%, while the rate of inflation has averaged just 3%. Index funds offer a simple way to invest in a basket of stocks that track a particular market index, such as the S&P 500. This type of investment can help you stay ahead of inflation by providing exposure to companies that are expected to benefit from rising prices.
Boost your income.
One way to offset the effects of inflation is to bring in more money. If you’re employed, this may mean asking for a raise or taking on additional work hours or responsibilities. If you’re self-employed, it could involve raising your rates or finding new clients who are willing to pay more for your services. Another option is to invest in assets that generate passive income, such as rental property, opening a Groundfloor account for real estate investments, or dividend-paying stocks. This extra income can help you keep up with the rising cost of living and maintain your standard of living during periods of high inflation.
The Pros of Investing for Inflation
There are several key advantages to investing for inflation that make this strategy worth considering. First and foremost, investments that are able to keep pace with or exceed the rate of inflation will help to ensure that your purchasing power is maintained over time. This becomes increasingly important as you approach retirement and begin relying more heavily on your investment portfolio to support your lifestyle. Additionally, since most people's wages tend to increase at or slightly above the rate of inflation, investing for inflation can help to keep you ahead of the game financially.
Another key advantage of investing for inflation is that it can help to reduce the overall volatility of your investment portfolio. This is because investments that do well in periods of high inflation generally have a low correlation to other asset classes, which means they tend to move in different directions than other investments in your portfolio. This can help smooth out overall returns and make your portfolio less risky overall.
The Cons of Investing for Inflation
There are also some potential drawbacks to investing for inflation that are worth taking into account before making any decisions. One such drawback is that investments that have a history of keeping pace with or exceeding the rate of inflation often come with higher price tags than other investments. This means that you could end up paying more in fees and commissions over time, which can eat into your returns. Additionally, these types of investments typically require a higher degree of maintenance in order to stay on track, which could add additional costs as well. Finally, it's important to remember that no investment strategy is guaranteed to work all the time—even one as sound as investing for inflation—so there's always a chance that you could end up losing money despite following all the best practices.
Investment Strategy Ideas That Perform Well
Gold and Silver (Metals)
Gold, silver and other metals have long been considered safe havens during times of economic turmoil. That's because they tend to hold their value better than other assets when inflation is on the rise. Gold is particularly popular during periods of high inflation because it doesn't corrode or tarnish over time, which means it can be passed down from generation to generation. Silver is also a good choice for investors looking to protect their wealth from inflation because it has a wide range of industrial uses, which helps to keep its price stable.
Metals aren't for you? Investing in real estate can also be a good way to protect your wealth from inflation. That's because as the cost of living goes up, so does the rent that tenants are willing to pay. Additionally, if you purchase property in an area that is gentrifying, you may be able to sell it for a significant profit down the road. Just be sure to do your research before investing in any real estate property so that you don't overpay and end up in a money pit. This a reminder that Groundfloor can assist you in your real estate investment journey.
Treasury Inflation-Protected Securities (TIPS)
If real estate isn't for you, think bout TIPS. Treasury inflation-protected securities (TIPS) are bonds issued by the federal government that are designed to protect investors from inflation. TIPS are indexed to the Consumer Price Index (CPI), which means that their values increase along with CPI readings. TIPS are considered one of the safest investments you can make during periods of high inflation because they're backed by the full faith and credit of the United States government. However, they do have somewhat low returns compared to other investments, so they might not be right for everyone.
Money Market Fund
A money market fund is a type of investment that is made up of very short-term debt securities, like Treasury bills and commercial paper. Money market funds are often used by investors as a way to park their cash while waiting for better investment opportunities.
Why You Should Keep Cash in a Money Market Fund
There are several reasons why you should keep cash in a money market fund. First, money market funds offer safety and stability. Because they invest in short-term debt securities, money market funds are not subject to the same fluctuations as other types of investments, like stocks and bonds. This makes them an ideal place to keep your cash if you're looking for a safe investment.
Another reason to keep cash in a money market fund is that they offer liquidity. This means that you can access your cash quickly and easily if you need to. This is important if you're investing for short-term goals and need to be able to access your money quickly.
Lastly, money market funds offer competitive interest rates. Because they are considered low-risk investments, money market funds typically offer higher interest rates than savings accounts at banks. This means that you can earn more on your cash while still keeping it safe and accessible.
Commodities are natural resources that are used in the production of goods and services. Examples of commodities include oil, gas, copper, and wheat. Commodities tend to do well during periods of inflation because their prices increase along with the prices of other goods and services. However, commodities can be volatile, so they're not right for everyone. If you're thinking about investing in commodities, be sure to consult with a financial advisor first so that you understand all of the risks involved.
Now that you know about some of the best investments to make during periods of high inflation, it's time to start putting your money where your mouth is! Just remember to consult with a financial advisor before making any decisions so that you understand all of the risks involved with each type of investment. With a little bit of research and planning, you can ensure that your portfolio is well-positioned to weather any economic storm.