Markets have been volatile so far this year. Covid is no longer discussed in high drama TV news debates. Rather it is US monetary policy tightening and possible US recession risks and inflation that have taken centre stage.
I grew up in a household where annual budget planning is religiously followed, and lately, there has been an echo of that with the wife starting to complain about rising prices.
In simple terms, Inflation decreases the purchasing power of the money one holds. There are several factors which cause inflation, supply chain disruption, demand, fiscal policy, high manufacturing costs etc. all contribute to inflation.
Current US inflation is high, and the truth is that there is nothing a consumer can do to control Inflation as it is beyond their control. Inflation is also eroding our investment value and, hence, the key question among investors is what one should do to protect their investment value. And where should one invest to hedge against inflation.
Passive investors with the vision to create wealth over the long term should not time the market. They should also not worry too much about inflation either. One should systematically invest and continue to do so in good and bad times. Having said that, it’s imperative that you identify and keep inflation-hedged asset classes on the watch list and then strike a deal when inflation is shaping up. By this, you not only protect the value of your investment but also take advantage of inflation.
What is key to know is that keeping money idle is the biggest risk and that too in a currency subject to an inflationary environment. There are enough assets and securities that will protect you against inflationary pressure.
Invest in gold
Some argue that gold is not a perfect hedge against inflation. But, one would also agree that for solid portfolio construction, diversification is the key. Gold is the original ‘alternative currency’; it’s a physical asset and would mostly hold its value. Gold is a good hedge against uncertainty and a store of value. A small allocation to this asset class would only help.
Ideally, these investments should be made at the onset of the inflationary period. At the peak of the inflationary cycle they may not give desired results.
Rental income from real estate would generally keep pace with inflation. In key locations, they even beat the inflation. Investments made using fixed-rate mortgages will further amplify the positive impact. If single ownership investments are out of reach, try to invest in publicly traded REIT’s.
Ideally these investments too should also be made at the onset of the inflationary period.
A stock and bond portfolio is a straightforward investment strategy. Depending on your risk appetite you may choose the mix. Generally, 60:40 works well, but young investors may even consider 80:20. Selection of stocks and their underlying businesses is not easy and it’s best that you work alongside an investment advisor. You should also closely monitor tech businesses - they are asset-light and tend to do well in an inflationary environment.
Investors need to bear in mind that the current analysis is based on the expected stagflationary environment over the next several quarters. What may tip the balance is the onset of a recession, which may again lead to coordinated central bank actions. The ultra-loose monetary policy witnessed in the past may be repeated and lead to similar outcomes of rising equity markets and plunging bond markets.
Invest in yourself
Your biggest asset is you and upskilling is the only way you can be relevant in this fast-changing technology-driven world. Your return on investment would be good and you would always beat the inflation with better earnings either in your personal business or at your job.
Warren Buffett has time and again said that “One of the strongest protections against inflation is sharpening your skills and working to be at the top of your field. The best thing you can do is to be exceptionally good at something”.
The world will always value a specialist…