Investing for Inflation
A dollar today will not buy the same value of goods in ten years. This is due to inflation. Inflation measures the average price level of a basket of goods and services in an economy; it refers to the increases in prices over a specified period of time. As a result of inflation, a specific amount of currency will be able to buy less than before. Therefore, it is important to find the right strategies and investments to hedge against inflation.
The level of inflation in an economy changes depending on current events. Rising wages and rapid increases in the cost of raw materials, such as oil, are two factors that contribute to inflation. If you think inflation may not be as transitory as the Federal Reserve states, perhaps adding some of these will help offset the impact to your portfolio.
Gold: Gold has often been considered a hedge against inflation. However, gold is not a true perfect hedge against inflation. When inflation rises, central banks tend to increase interest rates. Holding onto an asset like gold that pays no yields is not as valuable as holding onto an asset that does. There are better assets to invest in when aiming to protect yourself against inflation.
Commodities: Commodities are a broad category that includes grain, precious metals, electricity, oil, beef, orange juice and natural gas, as well as foreign currencies, emissions, and certain other financial instruments. Commodities and inflation have a unique relationship, where commodities are an indicator of inflation to come. As the price of a commodity rises, so does the price of the products that the commodity is used to produce.
Equities: Stocks offer the most upside potential in the long term. In general, businesses that gain from inflation are those that require little capital such as technology and communication, whereas businesses engaged in natural resources could be inflation losers. According to Sean Markowicz, CFA, of the Hartford Funds, “Our research has found that equities outperformed inflation 90% of the time when inflation has been low (below 3% on average) and rising. But when inflation was high (above 3% on average) and rising, equities fared no better than a coin toss.” If we expect inflation to continue, we may see more volatility in equity markets.
Real Estate Income: Real estate income is income earned from renting out a property. Real estate works well with inflation. This is because, as inflation rises, so do property values, and so does the amount a landlord can charge for rent. This results in the landlord earning a higher rental income over time. This helps to keep pace with the rise in inflation. For this reason, real estate income is one of the best ways to hedge an investment portfolio against inflation.
At Potentia Wealth, we continue to see just how “transitory” the inflation we are experiencing really is and are constantly adjusting our portfolios to accommodate.