Don’t fall into the temptation of not investing during inflation.
Inflation is a term that describes an increase in the general level of prices that occurs over time. The Consumer Price Index (CPI) measures changes in prices and provides indications of how inflation affects consumer spending habits. Inflation has been under 2% for most of the past decade, meaning that many people haven’t felt its effects yet, but it’s important to be aware of what may happen in the future. Investing during inflationary times can be extremely profitable, but it’s also essential to understand why you shouldn’t panic when the value of your investments dips.
According to StatBureau, in April 2022 the inflation rate for selected countries stood as follows
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These high levels have not been seen in a long time. What should you be doing during these times? First, we need to understand what inflation is.
During inflation, the value of your cash will decrease. This means that you won’t be able to purchase as many goods and services. If you could buy a bike for 500 dollars a few years ago, it will now cost you 600 dollars. This means that the value of 500 dollars has declined.
Interest earned from your savings will also be worthless in the future. This is because inflation eats away at the purchasing power of your money. Whereas you will be happy seeing your bank balance go up with the value of interest, you need to reconcile the value of inflation with the interest rate received.
While cash may not be as valuable during times of high inflation, other assets will become more valuable. Investing in stocks and real estate are two examples of investments that tend to do well during periods of high inflation.
What causes inflation?
Inflation can be caused by changes in cost, demand, and fiscal actions by governments.
This is where inflation is caused by an increase in the cost of production. This could be changes in the costs of raw materials or an increase in wages. We have seen the recent swings in prices of petroleum products.
As the name suggests, demand-pull inflation occurs when there is generally high demand for goods and services. When this happens, prices rise to balance the equation. Prices will also rise if traders realize they can get away with asking for more for their products.
Fiscal and Monetary policies
Government can increase the amount of money circulating in an economy by reducing taxation (fiscal). This certainly increases demand in the economy, thereby causing inflation. Through the Central Banks, the governments can use various monetary policy actions to increase the funds available for banks to offer loans. This once again will result in inflation because there will be more money chasing a limited supply of goods and services.
Where to invest during inflation?
Investing during inflation is a strong show of character of investors and a smart move as well. During this period, the purchasing power of money is shrinking as more money chases fewer goods. The sooner you move your wealth from money into selected assets, the sooner you stop your wealth from losing value. Below are some options you can choose when making investment decisions.
Stock markets offer a marketplace for stocks. Stock prices increase when there is a higher expectation for future profits. During periods of high inflation, companies can adjust their prices to match the increased cost of living. As long as investors believe that a company will be able to continue making profits, it’s likely that its stock prices will continue to rise.
Investors in stocks have two sources of revenue. Dividends and capital appreciation.
When a company has operated for the whole year, accounts are audited and profits are declared. Dividends are the amount of cash paid to shareholders out of profits. Blue-chip stocks have a proven track record and are a safe haven for conservative investors.
Shares of listed companies are quoted at market value. The value is determined by the market sentiments of buyers and sellers. If the perception is positive, then the prices value of the stock will go up.
Real estate is another good investment option during times of inflation. When the standard of living increases, people are more likely to want to buy homes. This drives up the price of real estate and results in higher returns for investors.
For decades, the prices of real estate have been on an upward trajectory. This has been mainly due to the demand for housing and office space. Industrial growth has added to the demand for warehouses. There have been times when real estate bubbles have seen prices fall. But, this is rare. Investing in real estate is a good hedge during inflationary times.
Investing in gold is often seen as a safe bet by many investors, however, this isn’t always the case because gold prices usually increase with uncertainty in the economy. The price of gold can also take a dip due to market dynamics.
Gold prices have generally been rising in the past decade. This is because a lot of investors see it as a safe haven during times of economic turbulence. Gold is also considered safe by governments. That is why you see many countries holding reserves in gold.
Start-ups and new technologies
Investing in start-ups and new technologies can also be rewarding. Investors who come in early take high risks. Companies are willing to offer generous value propositions at this stage to attract capital. These investments will appreciate in value as the start-up becomes profitable.
New technologies provide opportunities for growth, which will increase profits during periods of high demand. People that invested 1000 shares in Facebook in May 2012 spent about 40,000 dollars. Today, these stocks have a market value of more than 330,000 dollars.
Exchange-Traded Funds (EFTs)
An ETF is a collection of securities, shares of which are sold on an exchange. They can include stocks, mutual funds, or bonds. They are traded in the exchange, meaning that their prices are marked to market. Depending on the choice of securities in the basket, the returns are bound to be balanced. ETF shares represent partial ownership of a portfolio put together by a manager.
This is a good way to diversify your portfolio. You can also learn about investments in Commercial Papers.
The goal should be to have your money working for you, without necessarily losing value due to inflation. Do you need cash or liquid assets? Yes. Cash comes in handy to sort out day-to-day expenses and those emergency situations. But cash and other liquid assets keep losing value by the day.
Your next consideration is cash alternative assets. Near cash, investments should be next on the ladder. Stocks (also referred to as securities) are good investments in your portfolio. It is critical to diversify your investment in securities, even if you love that one company. Always have an eye for that gem that no one else has identified.
Real estate investments should be guided by a long-term view. They are not quick to liquidate, but they appreciate in value over time. Consider the rental income that will be generated over time and developments around. Consider any risks that could wipe away the value of your property. It is crucial to follow the real estate inflation in the House Price Index data that is regularly published.
Gold has remained the most trusted hedge against inflation over the years. Demand for gold keeps going up, mainly from China and Asia. Governments also keep reserves of gold as part of their reserves. The mining of gold is becoming more expensive, even with technological advancements. This is one piece of investment that has been trusted by investors over the ages.
Cryptocurrencies have slowly gained attention. This is a very high-risk asset class. You should only invest what you are happy to lose. You should never borrow to invest in cryptocurrencies. Scammers have also reaped people off millions of money. That said, people have made crazy amounts of money in Bitcoin and other similar digital assets.
Understanding inflation will lead you only one way. Investing. Your next consideration is where to invest and how. Investment strategy should be based on your risk appetite. It should be able to take care of daily requirements, emergencies, and your long-term financial security. If you have a nerve for risk, then buy some cryptocurrencies. Treat cryptocurrency investments as expenses, just like that dinner expense. That way, in case they go south, you don’t suffer heartache.
If you have a low-risk appetite, perhaps you can go to Exchange Traded Funds that offer a balanced return.
What excuse do you have? Invest irrespective of the inflationary times. In fact, there will always be inflation because Central Banks budget for them each year.
Thank you for reading.
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