The economic phenomena of asset price inflation occurs when the price of assets rises and becomes inflated. Low interest rates are a common cause of increasing asset prices. When interest rates are low, investors and savers can’t make easy money by investing in low-risk instruments like government bonds or savings accounts. To receive a return on their money, investors must instead purchase other assets like as stocks and real estate, causing asset price inflation by bidding up the price.
When people talk about inflation, they usually mean the cost of everyday goods and services, which the Consumer Price Index measures (CPI). Financial and capital assets are not included in this index. Financial asset inflation should not be mistaken with inflation of consumer goods and services, as the two categories’ prices are frequently separated.
Shares and bonds (and their derivatives), as well as real estate, gold, and other capital commodities, are examples of common assets. Alternative investment assets, such as fine art, expensive watches, and venture capital, can also be included.
What exactly are inflation-protected assets?
An inflation hedge is a financial instrument designed to safeguard a currency’s purchasing power against a loss of value caused by rising prices, either macroeconomically or due to inflation. It usually entails purchasing an asset with the expectation of maintaining or increasing its value over a fixed length of time. Alternatively, the hedging could entail taking a larger position in assets, which may depreciate at a slower rate than the currency’s value.
Inflation has an impact on what assets.
Asset Classes and Inflation Inflation affects liquid assets in the same way it affects other assets, with the exception that liquid assets tend to rise in value less over time. This means that, on balance, liquid assets are more exposed to inflation’s negative effects.
Is gold a good inflation hedge?
- Gold is sometimes touted as a hedge against inflation, as its value rises when the dollar’s purchase power diminishes.
- Government bonds, on the other hand, are more secure and have been demonstrated to pay greater rates as inflation rises, and Treasury TIPS include built-in inflation protection.
- For most investors, ETFs that invest in gold while also holding Treasuries may be the best option.
Where should I place my money to account for inflation?
“While cash isn’t a growth asset, it will typically stay up with inflation in nominal terms if inflation is accompanied by rising short-term interest rates,” she continues.
CFP and founder of Dare to Dream Financial Planning Anna N’Jie-Konte agrees. With the epidemic demonstrating how volatile the economy can be, N’Jie-Konte advises maintaining some money in a high-yield savings account, money market account, or CD at all times.
“Having too much wealth is an underappreciated risk to one’s financial well-being,” she adds. N’Jie-Konte advises single-income households to lay up six to nine months of cash, and two-income households to set aside six months of cash.
Lassus recommends that you keep your short-term CDs until we have a better idea of what longer-term inflation might look like.
Are diamonds a good inflation hedge?
Diamonds are frequently used as a low-volatility inflation hedge. Diamond prices are three times less volatile than silver prices, two times less volatile than iron ore prices, and 1.5 times less volatile than gold prices, according to a 2014 Bain & Co. Diamond Report.
How do you protect yourself from hyperinflation?
If rising inflation persists, it will almost certainly lead to higher interest rates, therefore investors should think about how to effectively position their portfolios if this happens. Despite enormous budget deficits and cheap interest rates, the economy spent much of the 2010s without high sustained inflation.
If you expect inflation to continue, it may be a good time to borrow, as long as you can avoid being directly exposed to it. What is the explanation for this? You’re effectively repaying your loan with cheaper dollars in the future if you borrow at a fixed interest rate. It gets even better if you use certain types of debt to invest in assets like real estate that are anticipated to appreciate over time.
Here are some of the best inflation hedges you may use to reduce the impact of inflation.
TIPS
TIPS, or Treasury inflation-protected securities, are a good strategy to preserve your government bond investment if inflation is expected to accelerate. TIPS are U.S. government bonds that are indexed to inflation, which means that if inflation rises (or falls), so will the effective interest rate paid on them.
TIPS bonds are issued in maturities of 5, 10, and 30 years and pay interest every six months. They’re considered one of the safest investments in the world because they’re backed by the US federal government (just like other government debt).
Floating-rate bonds
Bonds typically have a fixed payment for the duration of the bond, making them vulnerable to inflation on the broad side. A floating rate bond, on the other hand, can help to reduce this effect by increasing the dividend in response to increases in interest rates induced by rising inflation.
ETFs or mutual funds, which often possess a diverse range of such bonds, are one way to purchase them. You’ll gain some diversity in addition to inflation protection, which means your portfolio may benefit from lower risk.
How can I plan for inflation in 2022?
During inflationary periods, stocks are often a safe refuge. This is because stocks have typically produced total returns that have outperformed inflation. And certain stocks outperform others when it comes to combating inflation. Many recommended lists for 2022 include small-cap, dividend growth, consumer products, financial, energy, and emerging markets stocks. Industries that are recovering from the pandemic, such as tourism, leisure, and hospitality, are also receiving a thumbs up.
Another tried-and-true inflation hedge is real estate. For the year 2022, residential real estate is considered as a safe haven. Building supplies and home construction are likewise being advocated as inflation-busters. REITs, or publicly traded organizations that own real estate or mortgages, provide a means to invest in real estate without actually purchasing properties.
Commodity investments could be one of the most effective inflation hedges. Agriculture products and raw resources can be exchanged like securities. Gold, oil, natural gas, grain, meat, and coffee are just a few of the commodities that traders buy and sell. Using futures contracts and exchange-traded funds, investors can allocate a portion of their portfolios towards commodities.
During inflationary periods, bonds are often unpopular investments since the return does not keep pace with the loss of purchasing power. Treasury inflation-protected securities are a common exception (TIPS). As the CPI rises, the value of these government-backed bonds rises, removing the danger of inflation.
TIPS prices rose dramatically in tandem with inflation expectations in 2021. To put it another way, these inflation hedges are no longer as appealing as they were a year ago. Savings bonds, which the US Treasury offers directly to investors, are attracting some inflation-avoiders.