What is Inflation?
Inflation is defined by the sustained increase in the price of goods and services due to a fall in their supply. A high rate of inflation can force average price ranges to skyrocket. Over time, inflation washes away the value of the nation’s currency.
During high inflation, certain assets outperform the rest. These assets include specific commodities such as market stocks and inflation-protected bonds.
How to Measure Inflation:
Economists measure inflation by calculating the assets used by an individual during their daily lives. However, inflation can also be measured using indexes such as the Wholesale Price Index and Producer Price Index. Inflation calculators equipped with most financial and economic websites can also be of use.
Inflation effects become problematic when an individual has to pay more than their affordability for the goods and services. The two common gauges of consumer inflation are the Personal Consumptions Expenditures index and the Consumer Price Index.
The Federal Reserve is responsible for maintaining 2% inflation over the years. When it exceeds the limit, the Federal Reserve reduces inflation by increasing interest rates or by other monetary policies.
Why Inflation Occurs
Inflation occurs when demand begins to rise at a rate that is greater than the supply. Market demand forces the average prices of products to rise. Also, the increase in the cost of production due to higher labor costs or the increase in the price of a commodity makes them more expensive.
The two most important causes of inflation are wage inflation as well as rent equivalents which are the cost of owning or renting a dwelling.
Profitable Investment Ideas
Real estate – Real estate is a wise choice for a profitable investment plan, one might earn a profit from it in two ways. Firstly, the value of the property increases over time. Also, rental income can be generated from it, which can be compounded over time.
This kind of investment helps the individuals keep pace with the general rise in prices across the economy. Real estate investment includes direct ownership of the assets and indirect investment through securities.
Investment in Commodities
For centuries the leading commodities to have increased in value are gold (other precious metals too) and crude oil. Investment in gold can also be done in two ways; an individual may save gold coins and ingots, and jewelry in their locker. Investing in the stock of a company involved in the gold mining business has the same outcome. They can also invest in a mutual fund or Exchange Traded Fund (ETF) that specializes in gold.
Since modern society almost becomes immobile without fuel, oil is an appealing option for investors when the prices increase.
Other commodities in the same reference include cotton, soybean, and orange juice because of their increased monetary value.
Investment in Bonds
As long as an economy experiences inflation, investing in bonds may backfire. This is mostly due to high rates of interest caused by inflation. However, this can be avoided when investing in inflation-indexed bonds. Treasury Inflation-Protected Securities (TIPS) have gained popularity in the US under the Consumer Price Index (CPI).
When the Consumer Price Index rises, the base value is raised as well which results in the increase of interest payments. There are two kinds of investments, high yield debt is known to gain more value during inflation because investors turn to the higher returns offered by this riskier-than-average fixed-income investment.
Stocks are one of the best ways to keep pace with economic inflation, although not all equities are equal. High dividend-paying stocks have more chances to get hammered in times of inflation. The investors need to focus on companies that can pass their rising product costs to customers, such as those in the consumer staples sector.
Leveraged loans are instruments based on floating-rates, which means that the banks and lenders can charge more interest rates so that the return on Investment (ROI) stays stable during inflation. The individual may invest in Mortgage-backed securities (MBS) and collateralized debt obligations (CDOs). All of these require good amounts of investments. So, for most retail investors, the available course is to buy a mutual fund or ETF that specializes in these income-generating products.
Benefits of Investing During Inflation
We need to note whether the inflation is rate creeping up slowly from 0% to 2% per year or is it increasing from 10% to 20% per year or increasing at a rate of 40% causing hyperinflation. Hyperinflation can push an economy towards bankruptcy. But it is said that moderate inflation is helpful for the economy.
But inflation helps it easier for debtors, as they repay their loans with money which values lesser than when they had borrowed. This encourages borrowing and lending, which increases spending at all levels.
The primary pro of investing during inflation is to preserve the portfolio’s buying power if the individual. The second reason is that Investments keep growing. It can also lead to diversification, which is always worth considering.
Cons of Investment During Inflation
Nothing is free of cons, so it’s better to be aware of the problems that might come in the way of investments during high inflation.
The first drawback one needs to be aware of is there is no guarantee. Traditional inflation hedges might not always work.
If an individual has long term plans or timetable, it’s better not to change them.
The Bottom Line
So, in this article, we have discussed the investments which might be beneficial during inflation. The wisest choices on asset investments include commodities, real estate, inflation-protected bonds, and late-cycle stocks. Increases in wages and rent equivalents generally are major driving forces behind Inflation.
Like the Lebanese financial advisor Jay Hutchins puts it, “The real problem you run into with any kind of inflation hedges is that if you don’t already have them when inflation is around the corner, you’ve missed the boat.”
Hope this article will help you select the best profitable investment plan in inflation.