The principle of financial planning lies in preparing for the future. The future can be unpredictable. Moreover, you may not have the same opportunities, zest, and age to work as hard as you can now to earn and save money. Therefore, the onus of saving, investing, and accumulating a large corpus that can last you in retirement and old age depends on how you manage your finances when you are younger. The strategy of long term planning and investing works since it offers you considerable time to save and invest little by little to build a large corpus. Moreover, it distributes risk and cuts down short term volatility, thereby strengthening your returns. However, preparing for a time in the future can be hard. You have to be certain of your goals, so you can choose the right investment instruments. In addition to this, you also have to be careful of inflation.
Inflation refers to the loss of purchasing power of a currency. This means that the value of money lowers with time. A $50 dollar bill that can give you a decent meal today, could buy you an Apple iPad in 1960. The purchasing power of $50 in 1960 is equivalent to roughly $469.51 in today’s times. This is why when you prepare for the future, you must account for inflation in order for your money to hold its ground when it is time to finally use it.
An inflation surge refers to a time when the prices of goods and services are at their highest. This happens when the demand for a product increases. The demand signifies the will of the customers to pay a higher price for a particular product. Inflation can also arise when the costs of production increase. This usually happens when the prices of raw materials and the costs of labor rise.
The United States saw the worst inflation surge in 2021 since the year 1982. The inflation rate rose to a whopping 6.8% in 2021, bringing the need for investors to focus on the impact of inflation on their investment portfolios more than ever. To better prepare for rising inflation and tackle its adverse effects, you may consult with a professional financial advisor who can guide you on the best practices to adopt to mitigate the effects of inflation on your investment portfolio. Keep reading this article to know how to prepare for inflation.
A lot of investors believe that inflationary surges are not permanent or frequent.Even if you look at the past inflation surges in the U.S, you will find that the inflation rate reached 6.8% after nearly 40 years. But, a surge, however long or short, does affect your investments. The typical financial portfolio of 60% stocks and 40% bonds gets negatively impacted when inflation rises. Historically a 60 to 40 ratio has yielded 9% returns in a year. However, the same has yielded only 2% when inflation has surged. Therefore, you need to have a different approach t and know the most suitable inflation proof investments that can be a part of your portfolio during such surges.
Here are some of the best investments that you can make during inflation:
TIPs come with different maturity periods of 5, 10, and 30 years and require a minimum investment of $100. Most bonds have a fixed interest rate. This rate does not change during the entire term and remains the same until maturity. However, TIPs offer different interest rates during different inflationary periods, thereby increasing the chances of earning higher profits. When you invest in TIPs, you are paid an interest every six months. You will receive a higher interest payment in the case of inflation and lower interest payment in the case of deflation. Moreover, upon maturity, you receive the inflation adjusted invested capital. But if the principal amount is more than the inflation adjusted amount, the higher of the two would be paid to you. So, you have nothing to lose here.
Gold also helps diversify your investment portfolio. A well-diversified portfolio is the simplest way to combat inflation and any other risk. Having a mix of adequate investment options that can deliver returns in inflation as well as deflation can be a great strategy to combat the effects of each on your growing wealth. And gold does just that. Fixed-income instruments like corporate, government and municipal bonds and certificates of deposit (CD) do not fare well with inflation. But gold can be one of the best investments during hyperinflation as it is a good substitute for bonds.
When the demand for goods and services increases, there is an inflation surge in the country. This demand also increases commodity prices. This is why investors always turn to them when the purchasing power is on the decline in the economy. The prices of commodities largely depend on the economy and its state. If the economy is booming, the demand will also be high, and if the economy is falling, the demand would consequently drop. Inflation does not always have to be a negative thing. There are ways to turn it to your benefit, but it is important to know how to profit from inflation. Commodities trading can be one such way to use inflation to your benefit. You can invest in them through exchange traded funds or ETFs. You can also trade in them through derivatives, such as futures and contracts.
REITs refer to companies that own, manage, or operate other income-generating real estates, such as office complexes, warehouses, residential buildings, commercial estate, and more. When you invest in a REIT, you are paid regular dividends. As stated above, the income earned from rent and sale of a property rises with inflation. So, your dividends received are also increased. In the last 20 years, the returns from REITs have been higher than the rate of inflation. Hence, REITs are one of the best investments during inflation. You can invest in REITs directly or through mutual funds. However, keep in mind that to maximize your profits, it may be advised to invest in a REIT with a low expense ratio. In addition to this, you must also know that REITs have to pay property tax to the government. If the government increases the tax rate, the dividends may be affected. Moreover, the dividend you earn from your REIT investments is also taxed as your ordinary income. So depending on the tax slab you fall into, this may affect your overall taxability.
When it comes to specific crypto currencies like Bitcoin, there is also scarcity. There are a limited number of Bitcoins in the world – not more than 21 million. This leads to a high demand at all times. So, the chances of a loss in its value are low. In fact, some pockets of investors are also referring to Bitcoin as the new digital gold. There are also debates where Bitcoin is being compared to gold. The truth is that Bitcoin can be compared to gold and may even come out as a winner in many ways. For example, physical gold can have some limitations like storage costs, the fear of theft or loss, etc. However, Bitcoin does not require storage. It cannot be stolen or misplaced either. So, its ownership is a lot less problematic for an investor. Having said that, you cannot overlook the fact that Bitcoin has been around since 2009 only. Gold, on the other hand, has existed for centuries. Furthermore, Bitcoin is also highly volatile. Its past performance is not a clear indicator of its future returns. And there is no way to predict how it will fare against inflation in the years to come. Therefore, even though it may provide your investment portfolio with a safety net as far as inflation is concerned, it may still only be suitable for high risk, seasoned investors.
International bonds can reduce risk and offer exposure to other currencies and markets. They also offset inflation. But it is important to note that international bonds may also be risky. Their value can depend on the political and financial relations between the domestic and the foreign country and can fluctuate in case of an important global event. These bonds may also be susceptible to changes in taxation and regulatory rules. So, you may want to invest in them after having thoroughly understood all of these factors.
It is important to know what to buy before hyperinflation hits to minimize the damage of inflation on your portfolio. And while the inflation proof investments mentioned above can help you, you must know that the strategies that you use during an inflation surge may not always perform well during other times. Therefore, it is important to consult with a professional financial advisor during the different market and economic cycles and accordingly make changes to your investment portfolio. If you are looking to find out how to protect yourself from inflation, you can reach out to a professional financial advisor in your city.
To get in touch with a fiduciary advisor who may suggest suitable financial strategies to mitigate the effects of rising inflation or an inflation surge, use the free advisor match service. Based on your requirements, the platform scans through registered and qualified advisors to match you with an advisor suited to your needs and goals.
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