Is Inflation on the Horizon? Ways to Hedge Against Inflation

wooden letter blocks spelling out inflation

There are concerns about the economy and the affect of inflation. However, inflation isn’t a concern of which economists have a real consensus. The number of economists and policymakers raising alarms about inflation is small but growing. Some economists say the impending economic snapback and government stimulus will lead to an escalation of prices. However, nothing is set in stone. Consider these ideas on how to prepare for the chance of inflation.

What is Inflation?

Simply put, inflation leads to the increase of prices. Your current currency isn’t worth as much as it once was. Inflation impacts the cost of everything, from essential items and the cost of living, to borrowing money and government bond yields.

When measuring inflation, economists look at goods and services that people consume. Multiple price indices are available to provide data about what is happening in the market. In the US, the Consumer Price Index (CPI) is the most common measure of inflation. The Consumer Price Index measures the average change in prices of goods and services, and by proxy, the effectiveness of the government’s economic policy.

Ways to protect yourself

Keep a diversified portfolio with some inflation-safe investments

It might not be necessary to overhaul your strategy from an investing perspective. But when it comes to inflation, having a diversified portfolio with investments that are less sensitive to inflation can help protect you.

  • Commodities

Commodities are produced or extracted products, sometimes natural resources or agricultural goods. Inflation and commodities have a unique relationship. Commodities can help diversify your portfolio. Prices of products that are produced from a commodity increase when its price goes up. Some commodities tend to work well against inflation, like precious metals or energy products.

  • Stocks with Low Pricing Power

Pricing power is an economic term to describe the effect of a change in a firm’s product price on the quantity demanded of that product.[1] Pricing power is linked to price elasticity of demand. Which is a measure of the degree to which individuals, consumers, or producers change the demand, or the amount supplied in response to price changes.[1]

  • Treasury Inflation Protected Securities (TIPS)

TIPS help provide protection against inflation. Due to their coupons and maturities being directly tied to consumer prices, TIPS are a good source of inflation protection. However, TIPS can be expensive and they only pay 0.9% below inflation. In order to maintain purchasing power, inflation would have to increase by that amount over the decade. Consider if people are more likely to buy TIPS when inflation picks up, the price will likely increase.

  • Assets with Short Duration

Short-term investments are a financial investment that can be converted in five years or less. Examples can include CDs, money market accounts, government bonds, and high-yield savings accounts. Short-term investments have a few advantages. It’s easier to withdraw your money if you need it since they’re often more liquid.

Short-term investments can also apply specifically to financial assets owned by a company. These assets are what a company expects to convert into cash within one year.

Remember: we invest for the long-term

Long-term investing requires patience. When it comes to investing for retirement or saving for a rainy day, it’s best to let a market work for you and let it rise. However, investing your money for the long-term is more than just putting money in the stock market. You probably won’t get rich quick and see an immediate return. It takes time to grow your money, but by compounding interest, it’s well worth it.

Compound interest is the interest rate based on both the original principal and the accumulated interest from previous periods. Compounding can be a powerful factor in helping you create wealth when it comes to your investments. Compound interest also contributes to reducing wealth-eroding factors. Factors like, inflation, increases for cost of living and reduced purchasing power.

Prioritize building up your emergency fund

Having a prepared emergency fund can help cushion you from financial emergencies. Emergencies like illness, car trouble, job loss, and injury. It’s also important that your emergency fund has at least three to six months of your living expenses saved. During a recession, an emergency fund can be helpful no matter the yield on savings accounts or how inflation is doing. Emergencies are just as likely to happen during inflation.

Try not to overreact- remember prices rise every year. Panic can cause you to make poor financial decisions.

Inflation continues to exist. Price increases are one of the most common trends every year. Most of them for good reason, too. It’s possible to experience a deflationary economic downward spiral if inflation remains too low.

The accepted rate of inflation is around two percent annually. Paying off debt is easier when the rate is healthy. This provides the U.S. central bank with more room for cuts when the economy is weak. Also, with a two percent inflation rate, businesses and consumers can spend and borrow without overwhelming the economy. Panicking can lead you to making some harmful financial decisions. It’s important to take a step back and consider your options when dealing with inflation.

There is no denying inflation is a growing concern. However, that doesn’t mean you need to start making important financial decisions right away. Contact us and talk to a financial advisor if there is any way we can assist you.

Sources:

[1] Pricing Power, Investopedia

If Inflation Is Coming, Here Is What to Do About It, Wall Street Journal

Worried about surging inflation? Here’s 3 ways to protect your wallet from taking a big hit , Bank Rate

How much to worry-and not worry- about inflation, Vox

Short Term Investments, Investopedia

7 best short-term investments in July 2021 , Bank Rate

Compound Interest, Investopedia

Consumer Price Index (CPI), Investopedia

Commodities: The Portfolio Hedge, Investopedia

Investing involves risk including the potential loss of principal. No investment strategy can guarantee a profit or protect against a loss. Past performance is not a guarantee of future results. This material may contain forward looking statements and projections. There are no guarantees that these results will be achieved.

In general, the bond market is volatile as prices rise when interest rates fall and vice versa. This effect is usually pronounced for longer-term securities. Any fixed income security sold or redeemed prior to maturity may be subject to a substantial gain or loss. An issuer may default on payment of the principal or interest of a bond. Bonds are also subject to other types of risks such as call, credit, liquidity, interest rate, and general market risks.

Treasury Inflation-Protected Securities, or TIPS, are subject to market risk and significant interest rate risk as their longer duration makes them more sensitive to price declines associated with higher interest rates.