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Can you profit from inflation? Investment options to protect your money

There are many worrying implications of inflation, but the most obvious is the gradual loss of purchasing power.

As inflation takes root, the purchasing power of one dollar will decrease relative to its value in the past.

Due to historically low interest rates, long-term investors and retirees have become less vigilant against inflation during the previous decade. Inflation is a serious risk to a comfortable retirement in the future and must be taken into account as such.

Increased economic uncertainty is a direct result of inflation. Inflationary pressures lead the Federal Reserve Board to consider raising interest rates. Short-term stock market swings can be triggered by the Federal Reserve’s actions, and bond funds might lose value if interest rates rise.

In this article, we will discuss how you can profit from inflation, and explore the different options you might have to protect your wealth.

If you want to invest as an expat or high-net-worth individual, which is what I specialize in, you can email me (advice@adamfayed.com) or use WhatsApp (+44-7393-450-837).

How can you profit from inflation?

The prospect of inflation (and heightened uncertainty) is reason enough to reevaluate your investment strategy and make sure your portfolio is well diversified. The first step in protecting your savings from inflation is to invest in a diverse portfolio that is not overly concentrated in any one asset type.

When prices of goods and services rise faster than wages, customers experience a loss of purchasing power. For investors, this involves shifting some of their capital into assets that either rise in value or remain stable relative to inflation.

When inflation is high, these investments usually do well:

  • Products derived from commodities like gold, oil, and soybeans should increase in price as well.
  • Treasury Inflation-Protected Securities (TIPS) and inflation-indexed bonds have returns that rise when inflation rates rise.
  • The majority of price rises are absorbed by consumers, making consumer staples companies a solid investment.
  • Risky investments like mortgage-backed securities (MBS) and collateralized debt obligations (CDOs) often fare well when faced with inflation.

Despite the relative stability of real estate as an investment, you should proceed with caution in 2023.

The inability to pay off debt increases unemployment and weakens the financial system and the economy as a whole. The Federal Reserve Board of Governors of the United States has set a long-term goal of 2% inflation as the level most compatible with achieving both price stability and full employment.

Challenges arise for both investors and consumers when inflation rates suddenly spike or plummet by a large amount. This is due to the fact that they could pose serious problems for the economy. The effects they have on different asset types are similarly variable and frequently unexpected.

Inflation is a quantitative, quantity-over-quality economic indicator that tracks the rate of change in the price of a market basket of products. Increasing prices over time is what economists mean when they talk about inflation, and the rate of inflation is measured in percentage terms.

How do you track inflation?

Consumer Price Index (CPI), Producer Price Index (PPI), and Personal Consumption Expenditures Price Index are the most widely utilized economic data for tracking inflation. The Federal Reserve Board generally looks at the PCE Price Index to determine inflation.

The PCE is more comprehensive than the CPI since it is weighted by consumption indicators like those used to calculate GDP rather than by a survey of individual consumers’ purchasing habits.

The Consumer Price Index calculates the weighted average cost of a market basket of goods and services purchased by urban consumers. The BLS publishes monthly updates on this data.

The PPI-5 represents a weighted average of domestic producer prices. Many products and some services have their original sale prices included. The BLS also publishes monthly reports on this.

When compared to the Consumer Price Index, the PCE Price Index provides a more comprehensive picture of how consumer spending has changed over time. The U.S. Department of Commerce’s Bureau of Economic Analysis publishes it every month.

These three indices offer a “core” reading that is less sensitive to changes in food and energy costs. The Federal Reserve Bank of Dallas releases a Trimmed Mean PCE Price Index as an alternate inflation gauge; this index strips out of each monthly computation the spending categories with the largest price swings (in either direction).

How does inflation affect your investment returns?

Even though inflation’s impacts on the economy and asset values are difficult to anticipate, economic history and theory do provide some guidelines.

When inflation is present, fixed-rate debt assets (like mortgage-backed securities) suffer the most because of higher interest rates and principal repayments. If the inflation rate is greater than the interest rate, lenders will incur a net loss.

Some investors focus on the real interest rate instead of the nominal interest rate since it accounts for inflation.

Long-term fixed-rate debt is more vulnerable to inflation than short-term debt due to the greater and compounding effect of inflation on the value of future repayments.

Gold, and to a lesser extent other precious metals, has been the major haven during times of high inflation for millennia, driving up their prices.
Gold, and to a lesser extent other precious metals, has allowed many people to profit from inflation due to its tendency to rise in prices during inflationary periods.

The best kinds of assets to have while inflation is high are those that are certain to generate additional income or appreciate in value. A rental property whose rent is subject to periodic hikes is one example, as is an energy pipeline whose tariffs increase with the rate of inflation.

Value equities have been found to outperform growth stocks during inflationary situations. Companies with high earnings in relation to their present share price are considered value stocks. They also tend to have healthy cash flows, which buyers of rising prices tend to appreciate.

However, adjustments in interest rates are a regular monetary policy reaction to inflation, and growth stocks tend to be more susceptible to these changes.

Growth stocks had a great decade since inflation was virtually nonexistent. However, value stocks have been making a strong comeback recently. The conditions are right for them to keep succeeding.

TIPS, or Treasury Inflation Protected Securities, are marketable debt issued by the United States Treasury that are insured against losses due to inflation. In comparison to traditional fixed-rate bonds, TIPS also benefit from periodic inflation adjustments.

TIPS are a good option for the lower-risk portion of an investor’s portfolio if those goals are at the forefront of their investment strategy. The full faith and credit of the United States government guarantees principal repayment for holders of Treasury Inflation Protected Securities (TIPS).

How does inflation affect real estate?

Investing in real estate is common because it serves as a hedge against inflation and yields a steady stream of rental income.

Direct real estate purchases or investments through REITs or specialist funds are also viable options for investors.

When persistent inflation broke out in the 1970s, real estate investors benefited greatly. As the financial crisis of 2007-2008 shown, however, increased interest rates can also have a negative impact on real estate prices. The standard monetary policy response to rising inflation is an increase in interest rates.

Inflation tends to be favorable to single-family houses financed with modest fixed-rate mortgages. Your home’s value will rise in line with rising inflation, but your mortgage payment will remain unchanged. This is the foundation of increasing your wealth through home equity.

If rents in your area are going up, you can protect yourself by investing in real estate. Rents tend to increase during inflationary periods just like the prices of other goods and services. Mortgages, despite being less adaptable than leases, are preferable during periods of high inflation.

How does inflation affect commodities?

Gold and other precious metals are examples of commodities, as are a wide range of raw materials and natural resources. Generally speaking, the cost of production to meet rising demand is factored into market price increases.

During times of unpredictability, commodities are often considered a safe investment. Unlike stocks and bonds, which both tend to move in the same direction, commodities tend to move in the opposite direction and do not pay dividends because they do not reflect any underlying business.

When inflation rises, many people decide to put their money into commodities that are expected to appreciate in value.

Gold, and to a lesser extent other precious metals, has been the major haven during times of high inflation for millennia, driving up their prices.

In addition to investing in gold-backed mutual funds and exchange traded funds (ETFs), you can buy gold through a bullion or coin dealer.

Directly or indirectly through an exchange-traded fund (ETF) or a specialist mutual fund, investors can gain exposure to a commodity by purchasing shares in its producers.

Historically, many types of investments have been seen as insurance against inflation. Some examples of such investments are equities, bonds, and commodities.

Oil, copper, cotton, soybeans, and orange juice are all examples of agricultural and raw goods that fall under the commodity category. In an inflationary economy, commodity prices tend to grow in tandem with the prices of consumer goods that use those commodities.

The cost of gasoline and transportation rises, for instance, when crude prices rise. Futures markets and producer stocks are options for sophisticated traders interested in commodities.

However, exchange-traded funds that hold holdings in commodity futures would often underperform the growing commodity price due to the need to roll their futures positions as they mature.

How does inflation affect bonds?

Bonds are a somewhat illogical investment choice given the negative impact that inflation has on fixed-rate debt. Inflation-indexed bonds, on the other hand, have an interest rate that fluctuates with the rate of inflation.

U.S. investors often choose Treasury Inflation-Protected Securities (TIPS), which are linked to CPI inflation.

If the CPI goes up, so does the value of your TIPS investment. Since interest is calculated on the principal balance, any growth in the base value also results in a corresponding growth in the interest payments. Inflation-indexed bonds of other countries and other sorts are also on the market.

There are several entry points for inflation-indexed bonds. For instance, Treasury Inflation Protected Securities (TIPS) are available for direct investment through the U.S. Treasury or a brokerage account.

Some investors own them in mutual funds and ETFs. Think about trash bonds if you want to take a riskier bet. When inflation rises, investors seek out the greater profits offered by high-yield debt, as it is formally defined, rather than other, less risky fixed-income investments.

However, not all stocks are created equal when it comes to the ability to stay up with inflation. strong-dividend stocks, for instance, sometimes suffer the same fate as fixed-rate bonds during periods of strong inflation.

Consumer staples companies are a good example of a sector that can pass on higher input costs to consumers.

During times of high inflation, U.S. savings bonds suddenly become a viable investment option. I-bonds guarantee to keep up with inflation, despite the fact that you can only buy $10,000 worth per year and they are not marketable assets. Like Treasury Inflation Protected Securities (TIPS), they provide a principle return that is virtually assured.

Investing in I-bonds is a good way to protect the purchase power of a portion of your portfolio without expecting excessive profits.

It is prudent to consider alternatives to equities that have a chance of keeping pace with inflation given that many investments, such as cash and long-duration bonds, are likely to lose real value during inflationary periods.

What about debt obligations and loans?

Inflation can be protected against by using leveraged loans. Because of their status as a floating-rate product, banks and other lenders can increase the interest rate they charge to ensure that investors receive a return that is at least as high as the rate of inflation.

Structured pools of mortgages and consumer loans, known as mortgage-backed securities (MBS) and collateralized debt obligations (CDOs), are another possibility. Investors do not take title to the underlying debts but rather purchase securities that have the loans as their underlying asset.

Complex, potentially dangerous (depending on the rating), and typically requiring sizable initial investments, MBS, CDOs, and leveraged loans are not for the faint of heart.

Most ordinary investors will be best served by purchasing a mutual fund or exchange traded fund (ETF) that targets these kinds of income assets.

Investments for Inflation: Pros and Cons

Any investment, including any possible investment hedge, comes with its own set of advantages and disadvantages. There are benefits and drawbacks to each of the assets listed above.

Investing during inflation can help you keep more of your hard-earned money in the long run. The second is that you care about watching your savings increase.

It may lead you to diversify your holdings, which is always a good idea. Traditional portfolio construction principles, such as diversifying holdings to reduce overall risk, can be applied to both asset growth and inflation protection.

However, investors should not let inflation be the deciding factor in their portfolio. Do not deviate from your investment plan’s goals or timelines if you have set them.

If you need your portfolio to grow significantly, for instance, you should not have too much of it in Treasury inflation-protected securities (TIPS).

Do not invest in growth stocks for the long haul if you will soon need the money. Never allow your concern for inflation to push you beyond your acceptable level of risk.

No assurances can be made. Common inflation protection strategies do not always protect against price increases, and unusual market events can boost the performance of unlikely investments while leaving others in the dust.

When is inflation good?

The term “inflation” is commonly used to characterize the economy’s reaction to escalating oil or food costs. For instance, if the price of oil doubles from $75 to $100 per barrel, it will drive up the cost of transportation for everyone. There could be a domino effect on pricing as a result of this.

However, most economists hold a slightly different view on what constitutes inflation. The general price level rises as a result of inflation, which is a result of the relationship between the supply and demand for money.

The Federal Reserve aims for an inflation rate of 2% each year because it believes this level of growth is conducive to business.

Inflation could help homeowners who have committed to long-term, fixed-rate mortgages.
Inflation could help homeowners who have committed to long-term, fixed-rate mortgages.

Inflation mostly affects people by eroding their ability to buy things. The effects of inflation mean that the same amount of cash can buy less in different inflationary times, even while the denomination of currency remains the same.

The effects of cost-of-living adjustments may be felt in a person’s take-home income, but they are more likely to be felt in their day-to-day spending on things like food, housing, and other necessities.

When inflation rises, the Federal Reserve often raises interest rates on federal funds to combat the problem. The cost of debt increases as a result of a cascading impact of rising federal funds rates on other types of credit. Federal funds rates and credit card interest rates tend to rise.

A sluggish economy is a result of rising inflation leading to higher interest rates on debt. Inflationary times are characterized by rising prices and higher interest rates on new debt.

As a result of these two factors, businesses see a drop in sales and the economy suffers. The result might be lower company profits, layoffs, and increased financial strain on families.

This feedback loop may eventually lead to a downturn in the economy. The Federal Reserve juggles preventing inflation and keeping unemployment low.

However, the two elements frequently change places in different ways. Their policies frequently boost one while lowering the other.

When attempting to curb inflation, the Federal Reserve often runs the danger of triggering a recession, albeit this cannot be predicted with any degree of certainty.

Pros of Price Increases

Inflation is beneficial to output when the economy is operating below capacity and there is excess capacity in the form of idle labor or resources. More money in circulation means a higher level of aggregate demand. When there is a rise in demand, businesses respond by increasing output.

John Maynard Keynes, a British economist, argued that moderate inflation was essential for avoiding the “paradox of thrift.”

Consumers learn to delay purchases in anticipation of a better deal if prices are allowed to decline regularly as the economy becomes excessively productive, leading to the dilemma described above. This paradox has the overall impact of lowering aggregate demand, which in turn reduces production, causes layoffs, and weakens the economy.

There was a time when economists thought that rising unemployment might be countered by more inflation to keep prices from falling. The well-known Phillips curve describes this connection. The stagflation that hit the United States in the 1970s did a number on the credibility of the Phillips curve.

Who benefits from inflation the most?

By paying back loans with money that is worth less than what they borrowed, borrowers benefit from inflation.

Spending at all levels is boosted because borrowing and lending are encouraged. During an inflationary period, the value of a debtor’s $10,000 loan decreases each year.

Due to the debt’s falling worth during high inflationary periods, it is preferable to pay it off slowly from a purchasing power perspective.

In particular, inflation could help homeowners who have committed to long-term, fixed-rate mortgages. Higher interest rates discourage homebuyers, which can be good news for those already in a strong financial position.

Those who have been in their current jobs for a while or who are in safer positions tend to fare better as the economy slows down and the possibility of a recession rises. Budget cuts are more likely to affect those working in less desirable roles or in newer divisions/companies.

Finally, a higher inflation rate is usually accompanied with a decline in the value of a country’s currency relative to that of other countries.

As a result, the value of other currencies rises in comparison to the inflationary currency and experiences downward pressure. Inflation in one country could be good news for those who have foreign money and can convert it at a favorable exchange rate.

Inflation is dynamic; it evolves with time. Investors, consumers, and individuals would do well to keep in mind that government policies and monthly inflation rates might fluctuate significantly.

Inflation is often seen as a warning sign of economic trouble. Consumers are being hit with higher costs, a greater likelihood of job loss, and less disposable income. This is especially true for people whose wages and salaries do not rise in tandem with inflation.

When inflation is high, it might be difficult for consumers to make major expenditures. As the cost of debt rises in response to Federal Reserve rate hikes, many would-be homeowners find themselves unable to make the increased monthly payment.

Consumers who rely on durable goods are likewise negatively affected by inflation. Workers with non-renewable, short-term contracts, for instance, have no legal right to a raise in pay.

Fixed-income security investors are another good illustration. For the duration of the investment, the rate of return on fixed-income securities remains constant, even though it would be higher during an inflationary period.

Finally, there are several ways in which retirees are harmed by inflation. Inflation is factored into the cost of living increases made to Social Security and other government payments. However, benefit increases sometimes lag behind price increases, thereby forcing retirees to shoulder heavier costs.

Bottom line

Several financial assets are pegged to changes in the Consumer Price Index or the rate of inflation. A nominal return (albeit a small real return) is virtually assured if you hold these investments.

As a result of rising prices and the greater cost of debt, inflation can also put financial strain on households, encouraging spending. During times of low inflation, customers can stockpile funds, giving them more purchasing power when interest rates are high.

Inflation is seen as a threat and a detriment by many. Some people see inflation as an integral aspect of economic expansion.

The government’s reaction to inflation, which typically involves raising interest rates, slowing the economy, and increasing the danger of inflation, is an important factor to consider. Some people gain while others lose during inflationary times.

Since inflation occurs whether we like it or not, we might as well use it as an excuse to review our entire investment strategy. Despite a recent uptick in inflation, interest rates remained around record lows as of August 2021.

Keeping your investments diversified and adequately funded is one of the best ways to weather the storm of inflation.

Stocks offer the most long-term protection from inflation, and diversifying into other asset classes like real estate, commodities, TIPS, or I-bonds is prudent. Cash sitting idly will depreciate, and long-term bonds will be affected by a rise in interest rates.

It is always a good idea to take stock of your financial condition and make any necessary adjustments whenever inflation is present, whether it is temporary or not.

Pained by financial indecision? Want to invest with Adam?

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Adam is an internationally recognised author on financial matters, with over 739.2 million answer views on Quora.com, a widely sold book on Amazon, and a contributor on Forbes.

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Can you profit from inflation? Investment options to protect your money
Can you profit from inflation? Investment options to protect your money

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