Last week, I mentioned that there were a few ways to protect your money from inflation. I discussed how, in order to combat inflation, a percentage decline in the purchasing power of your money, you needed to grow the amount of money you had, to make up for the purchasing power that was lost to inflation. To grow the amount of money you had, without simply adding more, you could either rely on investments that grow due to demand (stocks, real estate, etc), or invest in income-generating assets (dividend stocks, rental income, bonds).
In this article, I’ll be discussing how investing (in general) can help mitigate the effects of inflation.
To preface, I want to say that I am not a registered financial advisor, everything I say is purely my opinion and for educational purposes only. Please consult a registered financial advisor before making any investment decisions.
With that out the way (thanks legal team), let's dive right in. To begin, always consider investing your cash, especially if you don’t need access to it for a long time (many years). Don’t leave it sitting around. One of the benefits of investing is that investing (depending on how profitable your investment is, of course) naturally mitigates the effects of inflation by providing returns that help make up for the loss of purchasing power.
The asset itself does not matter, instead, the returns (profits) it generates are what is important. As such, there is no one single asset that you can invest in and mitigate the effects of inflation. Instead, look at a variety of assets, and when examining potential investments, you should aim to purchase one that has a predicted yearly return above the average inflation rate (1-3% per year).
As long as your profits are equal to, or above the inflation rate, you will be able to minimize the effects of a constant decrease in the purchasing power of cash.
A number of assets have historically outperformed inflation, meaning they provide a higher yearly percentage return than inflation. For instance, the S&P 500, a stock index that tracks 500 American companies, has historically returned anywhere from 7-10% over the last 60 years. Investing in an S&P 500 ETF or index fund can be done easily through any brokerage and, using historical returns as a basis, has provided consistent profits which easily make up for inflation, and provide profits on top.
Investing in real estate has also proven to be profitable, historically speaking; even though the number of people has increased over time, the amount of land has stayed the same, so the value of land has increased (increasing demand, declining supply). Purchasing a home is often seen as a valuable investment, not only because you own your own home, but because real estate tends to increase in value over time. The average yearly rate of return for real estate, both commercial (real estate used for businesses), and residential (real estate used for people to live in), has been 10.5%, according to the National Council of Real Estate Investment Fiduciaries. Again, historically speaking, real estate has been an investment that outperformed inflation.
However, it's important to note that this will depend on a number of factors, like the location of your home, the surrounding area, the build quality, etc.
While, historically speaking, a few key investments have consistently outperformed inflation in the long term, it’s difficult to pinpoint a few assets that will certainly mitigate the impact of inflation, as anything that's profitable enough (+3% a year) will have this effect. Instead, as I mentioned earlier, the profitability of an investment will vary heavily from situation to situation, so it's difficult to generalize.
Consult a financial advisor for a detailed breakdown of investments, and if you don’t care about anything besides having your money stay protected from inflation, look into inflation-protected assets like series I bonds and Treasury Inflation-Protected Securities (TIPS), both of which are assets created with the sole intention of protecting the investor from inflation.
That brings us to the end of this week’s article. I hope you enjoyed the write-up and found it informative, as per usual, please message me with any further questions, thanks for reading, and I’ll catch you in the next one!