Few things are as terrifying as inflation. It eats away the value of your savings, and it’s currently making life difficult for most people. Worst of all, it could even reduce your investments to nothing if you’re not careful about which ones you pick. Not all investments are equally affected by inflation. Some are devastated by it, while others don’t feel a thing. During high inflationary periods, like right now in 2022, you want to carefully choose your assets to ensure your net worth doesn’t decrease. Ideally, you want to concentrate your investments on the 5 inflation-resistant assets we’ve mentioned below.
What is Inflation?
Inflation is a general rise in prices. It’s usually expressed as a percentage. For example, a 5% inflation rate means that most goods cost an average of 5% more than before. A 5% also doesn’t necessarily mean the price of everything rises by exactly 5%. It could be higher or lower. A 5% inflation only means that’s the average increase in price.
A previously $100 pair of shoes could cost $105 after 5% inflation. Notice that increasing prices means that your purchasing power decreases. You can no longer buy that pair of shoes for $100. So, unless your income also increases by 5%, your purchasing power decreases.
What inflation means for us is that your investments need to provide a higher return than the inflation rate for you to profit. Suppose you gain a 4% increase in your income, but inflation is 5%. That means despite the 4% income increase, your purchasing power actually fell by 1%.
To profit, you’d need an increase of at least 6% in your income. So, always keep inflation in mind when you’re investing.
How does inflation affect investments?
The exact long-term effects of inflation on an economy and its asset values are hard to predict. Economists debate this topic every day. But, thanks to research and history, we can recognize some general effects of inflation on the economy:
- Inflation hurts borrowers and helps lenders. When the value of money falls, lenders pay back loans with ‘cheaper dollars.’
- Assets that either increase in value or provide short-term income perform the best during inflation.
- Inflation hurts you unless your investment’s value rises more than how much inflation decreases it.
What this means for you is that the best investments during high inflation are the ones that either aren’t affected by it at all, or they appreciate in value at a higher rate than inflation.
Conversely, the worst investments during high inflation are the ones that aren’t protected from inflation and aren’t likely to appreciate higher than the inflation rate.
5 Best Assets to Invest in During High Inflation
These are the 5 best assets to invest in during high inflation:
1. Real Estate
Real estate is resistant to inflation since commercial and residential property both increase in value over time and provide rental income. The real estate investors can even buy shares of multiple properties with real estate investment trusts (REITs), further protecting them from inflation.
That being said, real estate isn’t immune to inflation and financial crisis. Remember the 2008 financial crisis? That sent housing prices spiraling down by 16%. What hurts real estate the most is rising interest rates, which happens to be the conventional monetary response to high inflation.
Higher interest rates increase the cost of borrowing, which makes it harder for people to buy real estate. The reduced demand decreases real estate prices.
Commodities like gold, silver, other precious metals, and agricultural products can also be inflation-resistant. The commodities are considered relatively inflation safe because of their intrinsic value. Gold bullion is intrinsically useful because you can use it for anything from chemical processes to jewelry, unlike non-tangible assets like stocks.
You can’t do anything with a Tesla stock except buy, sell, and receive dividends from it. So a Tesla stock’s value can be anywhere from nothing to anything. Gold bullion will always have value because it can be used.
You can’t expect massive returns from commodities. After all, it’s not like the world is desperate to get its hands on more gold. Gold is useful but not absolutely necessary, so its value only rises so much.
In contrast, a Tesla stock can technically be worth anything as long as investors are confident in the company. Your Tesla’s stock value could rise from $1 to $1,000 in the blink of an eye.
A bond is a loan where a lender provides a principal sum to the borrower, who provides you with periodic interest payments over time. Bonds are issued by both national governments and private corporations. In both cases, the borrower promises to return your initial capital by a set date.
Bonds are only a good investment against inflation if they’re inflation-indexed. Non-inflation-indexed funds lose value over time because inflation decreases the value of the interest payments you receive. An example of an inflation-indexed bond is the US Treasury Inflation-Protected Securities (TIPS).
TIPS is pegged to the Consumer Price Index (CPI), which measures inflation, so the value of a TIPS investment rises with inflation. As a result, inflation-indexed bonds aren’t affected by inflation. You’ll always receive the real value of your investment with an inflation-indexed fund.
4. Loans and Debt Obligations
A leveraged loan is a loan made to borrowers with poor credit histories or high existing debt. Leveraged loans are provided by banks that sell the debt to investors, like pension funds. Leveraged loans are resistant to inflation for multiple reasons.
First, loans are prioritized over bonds during bankruptcy. So you’re more likely to receive your money back if your borrower declares bankruptcy than other investors.
Second, the interest on leveraged loans can be increased. So, it’s possible for a leveraged loan to be inflation-proof.
Ideally, you want to invest in leveraged loans with businesses that provide essential services. They’re the least likely to go bankrupt.
A stock represents ownership in a company. If you own stocks in Tesla, that means you own Tesla in proportion to the percentage of stocks you hold in Testa. Simply, if you owned 50% of all Tesla stocks, you’d own half of Tesla. People invest in stocks whose value they expect to increase over time. Stocks are a form of capital that can be sold after it appreciates. Some stocks even provide periodic financial payments, known as dividends.
Investing in stocks may or may not be a good choice during inflationary times. On the good side, companies that provide essential services survive high inflationary pressures, especially if they’re service-based. Generally, the best stocks to buy during inflationary times are those in companies that provide vital services and pass rising input costs to customers. An example, energy companies perform well during inflation.
On the opposite side of things, high-dividend-paying stocks are the worst affected by inflation. These stocks provide monetary payments like non-inflation-indexed bonds. Inflation eats away at the dividend payments, so they lose value fast. Non-essential businesses, like luxury products, also experience reduced demand during inflation, so their stocks are less reliable.
High inflation means that prices are increasing, so the purchasing power of each unit of currency falls. The best way to hedge yourself against inflation is to invest in assets that are either inflation-proof or likely to appreciate. The best assets are stocks, inflation-index bonds, leveraged loans, real estate, and commodities.
A diverse portfolio with all these items is your best bet against inflation. Learn how to leverage capital budgeting when acquiring a diverse portfolio of assets here.