Inflation is defined as a rise in the general price level (i.e., the average prices paid by consumers for goods and services). It’s important to have investments during periods of inflation to protect your capital.
The 5 key investments to have during inflation include Tangible Assets (like Gold & Silver), Bonds, Index Funds, Real Estate Investment Trusts (REITs), and Real Estate Income.
Quick Recap: What Causes Inflation?
The causes of inflation are complex, are not fully understood, but it typically is caused by some combination of increased demand from economic growth and money printing (monetary policy) on the part of a central bank.
It’s sensible to have your money invested during periods of inflation, as the value of your liquid cash is in a sense depreciating, meaning you’ll want to get an appreciation on your investments to balance against that inflation rate.
The average yearly inflation rate for the US dollar is between 2 to 3 percent, but with all of the economic changes over the last year, many economists suspect that the coming 12 to 36 months could bring with them an unprecedented rise in inflation. With this on so many peoples’ minds, it’s important to consider the best investments for your cash to withstand this inflationary depreciation. In this article, I’ll cover the top five that I think you should be aware of to best protect your capital.
5 Investments to have during Inflation
Tangible Assets (Gold & Silver)
These assets are the two most common currency substitutes for precious metals. For gold, it has a very long history of being an asset that holds its value and is used as a hedge against inflation. Gold can be easily liquidated into cash whenever needed, making it an ideal investment to have during periods of inflation. It’s important to know that gold and silver aren’t exactly the same thing. The best way to think of them is as oil and natural gas are for fossil fuel: Oil prices tend to rise when natural gas prices rise, but if there is too much of one relative to the other, there can be supply problems.
Gold and silver can be purchased in the actual physical form from retailers, but there are also stocks of companies on the DOW and NASDAQ that represent the overall gold and silver markets. When you purchase gold or silver physically as an investment, they are not considered securities and are viewed differently by the IRS. This means that if you only plan to hold them as an inflationary hedge for under a year, you’ll want to consult with your accountant to make sure your taxes won’t get too complicated.
Bonds are debt instruments that give you interest payments from the issuer of the bond (generally a government or corporation) in exchange for giving them your money. That sounds pretty simple, but there is a lot more to it than that. The most important thing to remember about bonds is that they tend to be much less volatile than stocks but with less upside potential as well.
The interest rates on bonds are quoted in terms of a percentage of the principal amount. For example, you may see a bond quoted as having a 5% coupon rate. This means that for every $1,000 face value of the bond, you will be getting $50 in interest payments over the next year, an an annualised rate. This is a great way to earn interest off of your principal but without having to tie up as much capital upfront.
Bonds can be a great asset class when you’re looking for yield on your capital. Treasury bonds can be purchased through a brokerage account, its just the same as purchasing a stock. Corporations will issue bonds that have different maturity dates and yields over time. Some corporate bonds can also be purchased through the DOW and NASDAQ, but again because of the differences of how they are traded, I would consult with your accountant as to when it would make sense to purchase them.
These are funds that track a specific index such as S&P 500, and invest solely in stocks from this particular index. Index funds have been around for decades and are offered by most investment companies, like Fidelity and Vanguard.
When you invest in an index fund, you are investing in a passive management strategy. This means there is no attempt by the fund manager to guess what stocks will move up or down in value. Instead of trying to time the market and guess what will go up and down, index funds have historically provided an average return (less expenses) across all of the stocks that are included in a given index. For example, index funds that track the S&P 500, which is comprised of all of the top 500 companies on the New York Stock Exchange, tend to yield an average of 7-8% per year. This can be great for compound interest, especially if you reinvest dividends. This type of expected growth makes index funds a clear winner for those looking to hedge their money against inflation.
The only downside to an index fund is that it will always carry a bit more risk than bonds that you manage yourself. If the 500 companies in the S&P 500 were to dip by 10%, the index would dip by 10%. It tends to be safer than just picking individual stocks based on intuition and research, as individual companies can have much wider swings in stock price, which can while that can provide significant returns, it can also cause significant losses especially in times of economic recessions.
The risks that come with index funds come with being involved in the market at all. When you’re betting on an index fund, you’re betting on an entire industry (like tech – QQQ) or an entire country’s economic output (like the United States – SPY). It’s much riskier than a low yield bond, but you can rest assured that your capital will be preserved more effectively if inflation rates continue to soar well above 3%.
Real Estate Investment Trusts (REIT’s)
A REIT is a company that invests directly in real estate assets. These assets may include residential rental property, office buildings, hotels, or even things like parking lots and storage units.
REITs have grown in popularity over the last couple of decades as they tend to yield very high returns with little risk. For example, the Vanguard REIT ETF trades under the ticker VNQ. The extent to which a REIT pays out in dividends is generally proportionate to how much income it generates from its assets.
REITs can be purchased through your typical investment company like Fidelity and Vanguard. Similar to Index Funds, they are diversified across multiple assets in the same sector, which can help mitigate risk if one or two of the assets lose money. People often choose REITs over actual real estate because it’s easier to keep your money liquid while still getting exposure to the real estate market. In a traditional real estate investment, your capital can be tied up in the actual real estate for years, especially if you can’t sell like during a recession. However you can invest in most REITs through any normal brokerage. REITs also tend to have very low fees as compared to other equity investments. Another great benefit they offer is the possibility for tax-free gains, which is attractive for investors who are in high tax brackets. Lastly, REITs may be a good choice for investors trying to diversify their portfolio in order to minimise the risk of one stock losing a lot of money and being forced into bankruptcy.
Real Estate Rental Income
A rental income is not technically an investment, but it’s a good way to generate income for your portfolio. It’s actually a good application of the principle of controlling risk by focusing on only one asset class at a time. For example, you could buy rental properties where the tenants pay you rent in exchange for the use of your property. This is likely to be a low-risk investment as long as you hold on to your property long enough for its value to appreciate. In this way, you hold on to the property and earn money from its appreciation, perhaps with some help from a tax deduction if you’re a landlord who writes off rental expenses.
In summary, the examples above are just some of the ways you can use different types of assets to increase your income and decrease your risk of inflation by diversifying your portfolio. Remember that the key to investing is to invest in assets that you believe have a good chance for rising in value and earning some money over time.
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