How to deal with rising inflation
Transitory or not, inflation recently hit 5%, as of May 2021.
It hasn’t been this high in over a decade.
Dealing with higher prices on pretty much everything is an obvious effect, but how does inflation impact your savings?
Well, a helpful reminder for all you investors (and heads of households) out there, the calculation for inflation adjusted rate of return is:
{(1 + RoR) / (1 + inflation) -1} x 100
So if you figure you will make an 8% return on your portfolio this year, that’s great. But if inflation is 5%, you are actually making:
1.08 / 1.05 = 1.0285 -1 = 0.0285 x 100 = 2.85
Inflation adjusted return would be 2.85%
Remember, this affects actual purchasing power, as inflation is calculated using 12-month selections of the Consumer Price Index, which is published monthly by the Labor Department’s Bureau of Labor Statistics (BLS).
So if you have a lot of your money in a savings account that gives you 0.33%, you are actually losing -4.44% of your money’s value this year, if inflation continues at this rate.
If your investment portfolio lost nearly 5% in a year, instead of growing, you would be really upset. So if you are worried about losing money in the stock market, and are keeping a hefty portion in cash, consider other “secure” holdings that produce a better return.
Don’t get me wrong, holding cash is also good. In fact, it is a diversifying element in it’s own right, giving you a hedge against market drops, as well as allowing you flexibility to jump in on any new and immediate opportunity, but balance is key, and the external economic environment needs to be factored.
How do you protect your money during times of high inflation? I’ve noticed a few different ideas being circulated:
- Investing in Gold or Crypto (which are natural inflation hedges, or currency alternatives), to each with their own risk tolerance. As well as commodities, which go up in price with inflation, as they are the building blocks of pretty much everything else that goes up in price.
- Investing in Real Estate (in all its facets) which rises with inflation. The great thing about real estate, is that unlike most assets, it does not lose value once you buy it. In fact, it goes up in value. It also has flexibility in how it can produce income / wealth. Rents go up, remodeling / building / expanding all increase value, it strengthens your credit and net worth to own property, it can be leveraged. All good things when considering opportunity costs.
Couple this with the fact that we are at ALL TIME lows on interest rates (uncommon during inflationary eras) and that banks like lending for property investments, because they are quite simple, secure and easy to put a lien on, and you have what’s known in the scientific community as a “no brainer”.
- Equities. Stocks. Now I’m sure you immediately get a red light going off when I say that stocks can be a good hedge to inflation, because when inflation rises, costs of production goes up, rate hikes are on the horizon, capital will become more expensive to attain, and many other things can happen to bring fear of market drops. However, there are choices to be made, and not all stocks are the same. This is because not all companies are the same.
Tech stocks (specifically ones that have already attained good capital balances) are nimble, for example. They are not bound by manufacturing costs and factory outputs. They can cut costs easily and maneuver / refocus their efforts / change costs of services and products to match or beat industry averages easily. They also have the brightest minds in the world under their roofs, which should never be overlooked. Most importantly, these are the stocks that produce the highest, conceivably stable, returns. The best way to compete with inflation is getting a higher return than the inflation rate.
Dividends too are inflationary protectors. If a stock gives great dividends, you’d be happy to see that foreseeable return on your investment. Dividends however impact stock prices slightly, so some people would say it can be a bit of a wash. Consider consulting with your money manager.
- ETFs that aim to replicate the performance of the Aggregate Bond Index.
As inflation rises, speculators account for future federal rate increases, which gets the bonds rising to compete for investment allocation.
- Treasury inflation-protected securities (TIPS), a type of U.S. Treasury bond that are indexed to inflation in order to explicitly protect investors from inflation. Though they are long term maturities, and will decrease as well when inflation rates go down, so not necessarily a great option.
- Open a line of credit while it’s still easy. This isn’t as much an inflationary tale. It’s just a reminder that it is best to open a line before you need it, because if inflation, or anything else, makes you desperate for cash later, it will be much harder, if not impossible, to get that life line.
- One of my favorite pieces of advice though, is investing in yourself, the greatest inflationary hedge there is.
Strengthening your financial capabilities are a return that compounds endlessly. Education, business, experience, certificates, relationships, tools; these all cost time, money and effort, and will lead to great returns that outpace inflation.
If to give specific examples, you can purchase education or education credits (for future use), as well as invest in 529 college saving plans for your kids, which has multiple tax benefits.
You can buy those tools, upgrades or machines for your business that you had your eye on, or get that certificate of specialization that would give you an edge in the years to come.
Considering a better car for your business or family? Get it now if possible. Financing should be better now than it will be in the future.
Planning a wedding or event? lock in those venue rates as early as possible. Just make sure to insure that diamond ring ;)
This was a general thought crafting essay, and I have drawn information from a variety of articles on the matter. Each economic period has its own character and cycle, and it’s up to each person to manage their wealth to their best ability and in accordance with their beliefs and risk tolerance.
The important lesson to be learned here, is that inflation is real, it has an impact, and that it should, at the very least, be a factor in your decision making when growing to noticeable levels.
