With Inflation becoming a more and more prevalent topic and concern in the media It is good to dive into how to invest in an inflationary environment, and how to benefit the most from it. We need to recognize and understand that in the long term though inflation is only a probability, and not a certainty. Every investor needs to be familiar with inflation because it has the potential to significantly reduce the return on their long-term investments. I want to shed some insight on how inflation effects assets, and how to position yourself financially to benefit from it.
Inflation and how to profit from it
The recent increase in debt issuance by the government, and it’s almost blatant disregard for the expanding budget deficit of course raises the probability of inflation. In most cases Inflation and interest rates are coupled. When Interest rates rise bond investors will demand higher returns, which leads to higher budget deficits and more money printing by the government. This then creates even more borrowing and higher interest rates.
So how can we position our portfolios to benefit the most from an inflationary environment? In general, growth stocks with high price to earnings ratios benefit more from a lower interest environment, and could suffer the most when interest rates rise. Value stocks could benefit the most in this type of environment due to they are in general less leveraged, and have their cash flows near the present.
What To Invest In During Times Of High Inflation
With increased inflation we will see higher prices throughout the entire economy. A key thing to look for with companies that would potentially do well in a higher inflationary economy is if they are able to increase the prices of their goods or services without dramatically impacting their revenue. Some companies that have this feature are those with very strong brand recognition, monopolies, or tangible assets such as real estate or commodities.
During periods of high inflation Real estate becomes a popular choice as the rising prices directly impacts the resale value of the properties. Not only the underlying property value, but if the property collects rent the income it creates will rise with the rising prices driven by inflation. Investors can get real estate exposure in their portfolios without the need to purchase and manage the properties directly by purchasing shares of a REIT (Real estate Investment Trust).
Are historical Inflation proof assets still applicable?
In the past the go to inflation hedge has been precious metals (Gold, Silver, etc.) which have driven its price to rise on the global market. With the rise of Bitcoin and other cryptocurrencies this may not be the case anymore. Precious metals can be bought directly by physically storing coins or bullion yourself. Or there are also third party companies that store and protect your assets for you. However, you can gain this exposure indirectly by buying Mutual or Exchange traded funds that specialize in Gold or Commodities.
In general though, the best answer to fight inflation and preserve your portfolio’s buying power is to create and manage a diverse portfolio. This honors the time tested strategy of spreading your individual risk to a wide variety of holdings to prevent being overweight in any one class that may perform very poorly. With many things changing in today’s economy the traditional inflation hedges may not always work as there are no clear guarantees. As Warren Buffet once said “The arithmetic makes it plain that inflation is a far more devastating tax than anything that has been enacted by our legislatures. The inflation tax has a fantastic ability to simply consume capital.”
