How to Protect Against Inflation
Do you know what should you be doing to protect yourself from inflation?
"When I was your age, a loaf of bread was a nickel!"
Has someone in your life ever said a similar sentence to you? Or better yet, maybe you have begun to say things like that? You might remember when a movie ticket was $5, postage stamps cost a quarter, or when people in their 20's could afford houses.
Inflation is the culprit for these changes, and although it's going to occur whether you like it or not, there are things you can do to protect yourself from it. Let's take a closer look at some techniques you can use to help make sure you're not losing money to inflation.
What is inflation
Strictly speaking, inflation is when the government, expands the country’s money supply through the Federal Reserve — especially when the money supply grows faster than the economy (as measured by GDP).
In days gone by, this was accomplished by printing dollar bills and injecting them into the economy, but nowadays the same result is accomplished by adjusting bank balance sheets with just a few keystrokes.
But, most people don’t track U.S. money supply. Instead, when they think of inflation, they think of the symptoms, rather than the cause.
So, what are the symptoms of inflation?
- Rising CPI (Consumer Price Index)
- High housing prices
- Rising wages
- Higher grocery costs
Inflation affects consumers’ everyday lives — the costs of normal everyday transactions, like gas and groceries. But, it also impacts the value of savings and investments in significant ways.
How inflation affects savings
Inflation is sometimes called a “hidden tax,” because it widdles away consumers’ purchasing power without actually taking dollars out of their pocket. When inflation is high, dollars become worth less over time, and investors can buy less and less with a dollar — so they have to pay more and more for the same thing.
Inflation is the cause of gradual price increases for goods and services.
In addition to impacting consumers’ day-to-day expenses, inflation wreaks havoc with people’s savings. Any money that consumers’ hold in checking or savings accounts, CDs, or money market accounts, yields virtually no interest. Money held in savings can’t keep pace with even a modest amount of inflation.
But, this is a double-edged sword. When consumers owe money to a bank or other lender, and inflation picks up, the value of the money they owe actually declines over the life of their loan. So, if you have good credit, you can borrow and pay back your loan over time with dollars that are worth less than when you borrowed them.
How inflation affects investments
While inflation hurts savings, it can actually help the value of investments — especially a certain class of investments, like real estate, that serve as hedges against inflation.
Granted, there are other investments that tend to perform poorly in times of inflation. Financial companies like banks are just one example — these are companies that lend money to businesses and consumers, and dollars that they’re paid back are worth less than the ones they lent. A great tool to use is Seeking alpha to help you understand the market better!
Plus, quite often, when inflation starts in earnest, the Fed ends up raising interest rates in order to combat inflation. This slows down the housing market, car sales, etc., and businesses that rely on those sales don’t do well.
But, on the whole, when inflation picks up, being invested is better than not. When inflation is high, cash is trash, as the saying goes.
A note on real estate
Real estate is a particularly interesting asset during inflation, and deserves particular attention.
Traditionally, prices of real estate rise as the value of the dollar falls during times of high inflation. (Actually, the value of real estate tends to increase just about all the time, but it’s particularly beneficial when inflation is high.)
But, because interest rates will ultimately be raised to combat inflation, this can have an arresting affect on the housing market — making it difficult to sell or causing a short-term dip in prices. This is because when interest rates rise every dollar that someone borrows becomes more expensive.
Conclusion: When interest rates are higher, people can’t afford to pay as much for a house — at least, not until the effects of inflation trickle down in the form of wage growth. (This takes a while.)
Even though the real estate market is hot in a lot of areas around the country, this may still be a great time to buy a house — though not if you plan to move soon or may need to sell your house within a few years.
If you plan to hold a property for at least a few years and your local market isn’t already overpriced, this may be a great time to buy, to take advantage of further rising prices if inflation picks up.
6 tips for protecting against inflation
So, you think inflation may be coming — or you aren’t sure, but you want to protect yourself just the same. What should you do about it?
Here are some of our top tips to consider:
If you already own a home or investment property, you may want to refinance while interest rates are still low. You’ll repay your loan with dollars that are worth less than those you borrow now, and you’ll lock in a low interest rate before the Fed ends up raising rates to fight inflation.
Precious metals, as traditional stores of value, tend to do well when inflation is rampant. Granted, they’ve been less effective as inflation hedges in recent decades versus 40 years ago, with the opening of foreign markets and advent of ETFs and other vehicles. But, if you’re really worried about inflation, they can still be a great way to protect part of your portfolio.
3. Fill up your tank
If inflation picks up, oil is going to get more expensive. We’re not suggesting you buy oil drums and bury them in your backyard, or go to the gas station and fill trash bags with gas. But if you think inflation is going to pick up, don’t wait on expenses like fuel.
4. Buy real estate
Real estate is one of the best assets to own in times of inflation — not only because values tend to increase, but also because it’s easy to finance purchases with money that will decline in value as you pay it back. Whether you’re buying a residence, rental property, etc., it’s better to buy before inflation kicks in and the Fed raises rates.
5. Consider currency plays
If the U.S. dollar gets inflated, other currencies will do well, rising in value compared to the dollar (assuming they don’t get similarly inflated over the same period). This may even be true of cryptocurrencies — nobody knows yet because the dollar has yet to experience a period of high inflation since the advent of crypto.
So, if you think inflation is coming, you could sell dollars and hold other currencies instead. Or, you might consider buying foreign stocks in overseas markets.
6. Cash is trash
The bottom line when it comes to inflation is that investors should avoid holding cash, because during periods of inflation, it declines in value everyday. You’re almost always better off holding investments in times of inflation (as opposed to liquid savings), no matter what you invest in.
The bottom line
Inflation is when the purchasing power of the dollar declines as a result of new money being created and entering the economy. This can destroy the value of consumer savings, but also have a positive impact on investments — especially the values of certain hard assets that serve as hedges against inflation.
So, if you want to protect yourself against inflation, this is the time to avoid holding savings in cash. Instead, you should consider investing overseas, buying a house, or refinancing before inflation kicks in and the Fed raises rates.
The opinions expressed in this article are for general information purposes only and are not intended to provide specific advice or recommendations about any investment product or security. This information is provided strictly as a means of education regarding the financial industry. This post may contain affiliate links and/or paid placement that we earn revenue from.