Inflation is important in many countries since it can hurt the economy. However,
there are a number of ways you can shield yourself from it and even make money off it.
In this write-up, we will reflect on what causes inflation and some of the best
investments you can venture into during an inflationary period.
Meaning of Inflation and What Can Cause It
Inflation refers to the overall increase in the price of goods and services over a given period of
time, usually a year. Typically, inflation makes a currency worth less than it used to be, which
lowers its purchasing power. That means you must earn more money to keep up with the
current living standards.
When determining the rate of inflation, statistics agencies compare the current prices of goods
and services to their past prices. Here are contributing factors that can cause inflation:
1. Demand-Pull Effect
Demand-pull inflation can be experienced when the supply of goods and services
doesn’t meet consumer demand. An increase in this aggregate can be caused by too
much demand or too little supply, which translates to higher prices for everyone.
2. Cost-Push Effect
An economy can experience cost-push inflation if the supply of goods and services
declines while demand remains constant or surges. This can be caused by a rise in
production costs and usually drives prices higher.
3. Increased Money Supply
An increased money supply can also cause inflation in a country’s economy. If
the Central Bank prints more money, and the supply of goods remains the same, prices
will go up because there would be too much money chasing too few products and
services.
4. Devaluation
Devaluation is the deliberate reduction of a currency’s value against another currency. It
occurs when a country pegs its currency against another country’s currency.
For instance, the U.S. dollar devalues against the euro, which means you need more
U.S. dollars to import goods from Europe. This leads to inflation since a company might
be forced to raise the prices of its goods to match the increased cost.
5. Rising Wages
If workers believe that inflation will continue affecting them, they may demand an
increase in wages to keep up with their living standards in the future.
If their wages are increased, it will result in higher costs for running businesses since
there would be an increased cost of production. That means businesses must charge
more for their goods to maintain their profits.
Best Investments During an Inflationary Period
Inflation does not only affect the current prices of goods and services. It can also eat
into your investment’s returns. The best thing to do during an inflationary period is to
invest in assets with returns that can outpace the inflation rate. Here are some of them:
1. The Stock Market
Although equities can be a reliable investment during inflationary periods, they are a
suitable inflation hedge in the long run. Typically, stocks produce returns that exceed
inflation over time.
However, it’s important to note that some stocks do better than others in an inflationary
environment.
2. Real Estate
Real estate can be an excellent inflation hedge because it generates rental income
during an inflation period. Besides, you can also invest in building materials to shield
yourself against inflation.
In that case, you can buy shares from a real estate investment trust (REIT). However,
it’s worth noting that real estate can be affected by a rise in interest rates.
3. Treasury Inflation-Protected Securities (TIPS)
TIPS is also an excellent inflation hedge. They are bonds issued by the U.S government
and are designed to protect your portfolio against inflation.
Usually, they pay interest every six months, which depends on the fixed rate
determined at the bonds auction. They are different from other Treasury securities that
have a fixed principal.
The bottom line is that when TIPS matures, you get the increased amount if the
principal is higher than the initial amount. If the principal equals or goes below the
original amount, you get the initial amount.
4. Commodities
Commodities such as oil and agricultural products can be excellent at combating
inflation since their prices tend to increase with inflation. These raw materials can be
traded as securities. As such, you can direct a portion of your portfolio into such
commodities using futures contracts or through ETF investments.
However, commodities can be risky since their prices usually depend on supply and
demand. That means they are unpredictable investments that present a risk of incurring
losses.
5. Precious Metals Like Gold
Gold and other precious metals can be used as an inflation hedge, especially if a
country’s currency has lost its value. Over the years, investors have used precious
metals as commodities that can hold their value in an inflationary environment.
You can use them as a long-term investment to diversify your portfolio in economies
experiencing extreme inflation.
Final Thoughts
Despite inflation threatening your wealth, there are many ways to shield your investment
portfolio against it. As stated earlier, you can even make money off inflation with the
right knowledge. However, it should be noted that some investments give value in the
long run while others are ideal as short-term investments.
