Although it has caused a media stir, inflation is not all bad or good. It’s dualistic in nature—having positive and negative impacts on different parts of the economy. Understanding its effect on buying power and investments puts you in a position to protect your money during inflation and make the most of available opportunities.
As you likely know, inflation determines how quickly prices rise over a given period, typically a year. It’s generally a broad measure that includes goods and services across many industries and not just price increases on a few things. Inflation shows how expensive it is to live in a particular country year after year.
Learn how to offset high inflation impacts on your savings account and investments. Connect with a fee-only financial planner in the D.C. area.
Economists prefer a slow and steady inflation rate because it means businesses can be profitable and consumers are purchasing goods and services. On the other hand, rapid periods of inflation cause problems for lower and middle-income families and some businesses. In the most extreme case, it can be destabilizing and cause a spiral of rising costs.
Positive Effects of Inflation
Some higher-than-expected inflation can be good for people who owe money at a fixed interest rate. Business owners who can charge more for their products and real estate investors who can raise rents are two examples of people who may see an increase in revenue while their debt service remains constant.
Moderate inflation also encourages consumers to spend money, which can be good for the economy. Since the value of cash erodes during inflation and the costs of goods are rising, people tend to purchase items that hold their value or staples they can use over time.
Negative Effects of Inflation
Inflation can be challenging for lenders. While it’s an advantage for borrowers with fixed interest rates, the decreased value of money means banks are getting less return on their loans.
It can also be hard on people who live on a fixed income, like students and retirees. If your work or investment income is not rising with the rate of inflation, then your money doesn’t stretch as far as it did before. This may mean fewer vacations, consumer purchases, or a smaller entertainment budget for wealthy people.
For individuals who were already stretching their monthly budget to meet obligations, the rise in prices can create real hardship.
The Best Investments to Protect Your Money During Inflation
History does not repeat itself exactly. Cycles tend to look similar, but you cannot predict future earnings based on how a specific investment performed in the past. While these investments have generally done well during inflationary periods, it’s best to consult with your CERTIFIED FINANCIAL PLANNER™ in the D.C. area before executing your investment plan.
Let’s explore a few investments that tend to hedge against or perform well during inflation.
Treasury Inflation-Protected Securities
Treasury Inflation-Protected Securities (TIPS) are inflation-indexed bonds. In general, investing in bonds while interest rates are rising is not recommended because you lock your funds into a lower interest rate payment and limit your ability to access the rates as they increase.
However, inflation-indexed bonds like TIPS are tied to the inflation rate. When the Consumer Price Index rises, so do the base value of your TIPS investments.
Inflation increases the value of TIPS in two ways:
- An increase in base value
- The amount of interest paid increases with the base value
Backed by the U.S. federal government, TIPS is considered a safe investment. With a $100 minimum, they are very accessible to investors.
The stock market as a whole can see increased volatility and some losses during economic uncertainty or inflation, so many investors flee from stocks. However, not all equities are created equal, and some stocks can fare well as costs rise.
Companies that can pass cost increases on to consumers can continue to thrive as inflation rises. For example, consumer staples such as food, medicine, beverages, tobacco, and essential household products.
Certificates of Deposit (CDs)
With very low-interest rate payments, CDs are not likely to keep up with inflation. They are not a solid hedge to protect your money, but short to medium-term CDs may be a safe place to put some cash to reduce inflation’s impact.
CDs are purchased for a specific time frame where you can hold cash for a period and then access it.
Short-term bonds are not a solution for inflation. They are a similar strategy to CDs in that you can keep your funds accessible and earn some interest for a defined period.
If inflation causes interest rate increases, short-term bonds offer the flexibility to reassign your funds to benefit from higher rates.
Prices for essential raw materials and staples such as oil, precious metals, electricity, beef, orange juice, grains, and natural gas tend to increase with inflation, which makes them good hedges against it. However, commodity prices are vulnerable to unpredictable supply and demand changes, making them a risky investment.
The payoff on commodities can be significant, but so is the risk of losses. One way to ameliorate that risk is broadly investing in commodities through exchange-traded funds (ETFs). That way, you position yourself to benefit from those commodities that rise while reducing exposure to any hit hard by unexpected events.
Real Estate Investment Trusts (REITs)
Investing in real estate investment trusts (REITs) is not the same as purchasing real estate directly. REITs are usually companies that own and operate income-producing real estate and pay out dividends to their investors. Since property values and rents tend to rise with inflation, real estate can be a good hedge against inflation.
REITs have drawbacks, including:
- Not all property investments fare well in all economic conditions.
- As Treasury securities become more attractive due to higher interest payments, they can pull investors away from REITs and reduce share prices.
- REITs are sensitive to increases in property taxes which can eat into their cash flow and profits.
You Can Protect Your Money During Inflation
There are effective ways to protect your money during inflation, but hiding it under the mattress will not help. The key is to target parts of the economy that can keep up with rising prices and withdraw your funds from vulnerable investments.
Naturally, your specific strategy will depend on your personal goals and phase of life.
As CERTIFIED FINANCIAL PLANNERs™ in the Washington D.C. area, we provide over 90 years of combined experience. If you need guidance or fresh eyes on your investment strategy, connect with us to set up a no-obligation meeting.