Nothing is static in the world economy; what we see today bears little resemblance to a generation ago. And it is almost guaranteed that the economy will not look very familiar a decade or two from now. Financial stability in an economy gripped by uncertainty is a rational objective to aim for. And for many, slashing expenses and aggressive saving is the place to start achieving it.
However, saving funds for the future is not enough; we need to do more for the long term. Inflation erodes away a lot of the purchasing power of our hard-earned money. A simple rule of 72 calculation tells us that with a 5% inflation rate, the cost of living will double every 14.4 years. We are rowing upstream, and the speed at which we go up should be equal to or greater than the speed of the river’s downstream flow. So if sitting on cash and bank deposits are not adequate solutions for preserving our savings, what are reasonable alternatives? In this article, we are going to go over some of the best anti-inflationary assets that protect your purchasing power, each with its own reward-risk ratio.
Precious Metals
Gold and other precious metals have historically been considered strong hedges against inflation because they are intrinsically valuable physical assets. Precious metals tend to hold their value over time because they have a finite supply, don’t need the backing of a particular body, and they are and have been widely accepted as a medium of exchange all around the world throughout history. While they may not be the most profitable investment instrument since they have no yield, precious metals must have a place in every strong portfolio as they provide a good hedge against inflation and market turbulence in the long term. Read more to learn about how you can diversify your investment portfolio with precious metals such as gold, silver, and palladium.
Equities
Looking back at the times when inflation was rampant, like in the late 70s and early 80s, we can see that investing in equities has been one of the best long-term strategies to fight inflation. And it makes sense because when we are investing in equities, we are putting our money in companies and businesses that can raise their prices during inflationary periods.
No company is immune to inflation, and how they respond to external economic variables is dependent on the leadership and its decision-making. However, economic enterprises have the option to pass the inflation on to customers or make other adjustments that would be beneficial in the long run.
Equity investing is not risk-free, and there is always going to be short-term volatility in the market, but data shows that it builds wealth long term.
Real Estate
Real estate investments can also offer a good rate of return over the long term since their value increases in tandem with inflation. And this statement holds despite the housing crash of 2008.
Real estate investment typically has a higher barrier to entry in comparison to many other forms of investment like bonds and stocks. Flipping homes, renovating for profit, and renting apartments and commercial real estate are among the most popular real estate investment vehicles, and they all require a lot of capital upfront.
Investing in real estate has other drawbacks as well. Purchasing and selling properties involve high transaction costs. In addition, it requires a lot of patience as real estate is among the most illiquid assets, which means that it cannot be sold readily without a valuation loss. Also, real estate investment is not as much a passive activity as many believe it is. From maintenance to management, it takes a fair amount of involvement from the investors, unless it is done through real estate investment trusts or REITs.
Inflation-Linked Bonds
One hedge that has come to focus lately due to the recent unprecedented surge in prices is inflation-linked bonds. These bonds, which are known in the US as Treasury Inflation-Protected Securities or TIPS, effectively protect against inflation because they pay the ongoing actual accrued inflation rate in addition to a fixed real yield.
With nominal treasury bonds or normal bonds, the principal and interest (coupon payments) remain fixed for the entirety of the bond’s life. With TIPS, in contrast, the principal and interest are linked to the rate of CPI inflation, which means that when the bond matures, the principal you will be paid is going to be accordingly adjusted to the inflation rate.
So are inflation-linked bonds superior to nominal bonds? It depends. Inflation-linked bonds are always issued with an interest rate less than an equivalent nominal bond. And whether or not inflation-linked bonds will yield more returns than nominal bonds depends on whether the inflation exceeds a specific rate known as the breakeven rate over its lifetime.