Inflation rate
5 ways to protect investments from inflation and make profits in times of crisis Image Credit: Shutterstock

Dubai: High inflation should be on the watch list of any prudent investor because it can seriously undervalue any investment, as well as cause a dent in future cash flow.

Even if your money is growing in value, inflation has always been one such risk that can still reduce the bottom line value of your investments.

Moreover, with inflation soaring globally currently to the highest in over a decade, market statistics indicate that investors are tweaking their investment portfolios – and so should you.

Market experts often recommend that one way to inflation-proof your investments is to invest in assets that are likely to benefit from inflation while avoiding those that tend to be especially hard hit.

How inflation hurts different investments

Brief: How does inflation affect your investments?
Inflation is simply an increase in the average price level of a basket of goods and services in an economy. As a result of inflation, a specific amount of currency will be able to buy less than before. Therefore, it is important to find the right strategies and investments to hedge against inflation.

Over time, inflation can reduce the value of your savings, because prices typically go up in the future. This is most noticeable with cash.

For investments with a set annual return, like regular bonds or bank deposit, inflation can hurt profits — since you earn the same interest payment each year, it can cut into your earnings. If you receive a return of Dh200 per year, for instance, that payment would be worth less each year due to inflation.
Budgeting and saving money step by step
How does inflation affect your investments?

So how do you find investments that benefit from inflation, instead of losing their value? Here are five expert tips on what investments to consider and what to avoid when keeping your money inflation-proof:

1. Keep cash in money market funds

If you suspect that inflation will be a factor in the future, it's best to keep any cash-type investments in money market funds, Dubai-based financial planners often recommend to their clients.

When inflation hits, money market funds are interest-bearing investments, and that’s where you need to have your cash parked.

Since money market interest rates rise with the general market, you won't have to face the loss of market value that plagues fixed-rate investments during times of inflation.

As the rates money market funds pay fluctuate with interest rates, and they automatically adjust upwards as interest rates rise, there's no need to chase higher-yielding cash-type investments.

While it’s true that money market funds currently pay next to nothing, they're the cash investment of choice during periods of rising inflation.

2. Beat inflation by investing in gold ETFs instead of physical gold

Gold has often been considered a hedge against inflation. In fact, many people have looked to physical gold as an alternative currency, particularly in countries where the native currency is losing value.

These countries tend to utilise gold or other strong currencies when their own currency has failed. Gold is a real, physical asset, and tends to hold its value for the most part.

However, gold is not a true perfect hedge against inflation. When inflation rises, central banks tend to increase interest rates as part of monetary policy.

Gold has often been considered a hedge against inflation.

Holding onto an asset like gold that pays no yields is not as valuable as holding onto an asset that does, particularly when rates are higher, meaning yields are higher.

Experts opine that there are better assets to invest in when aiming to protect yourself against inflation. However, like any strong portfolio, diversification is key.

So if you are considering investing in gold, exchange traded funds (ETFs) with exposure to gold and it’s prices is a worthwhile consideration for investors looking to beat inflation.


3. Avoid long-term fixed-income investments

The investment that veteran investors recommend not putting your money into, during periods of inflation, are long-term fixed-rate interest-bearing investments.

Such investments can include any interest-bearing debt securities that pay fixed rates, but especially those with maturities of 10 years or longer.

The problem with long-term fixed-income investments is that when interest rates rise, the value of the underlying security falls as investors flee the security in favour of higher-yielding alternatives.

That 30-year bond that’s paying 3 per cent could decline in value by as much as 40 per cent, should interest rates on newly issued 30-year bonds rise to 5 per cent. Long-term fixed-income investments are ideal when inflation and interest rates are falling.

However, if you see signs that inflation is about to take off, like it is currently, you’d be better off moving your money out of long-term fixed-income investments and into shorter-term alternatives, particularly money market funds, experts further evaluate.

The investment that veteran investors recommend not putting your money into, during periods of inflation, are long-term fixed-rate interest-bearing investments.

4. Property investments are a boon in inflation

Rising inflation contributes to rising prices. That is a given fact. Rising prices also include rising rents for commercial properties. Property rental rates increasing while operating expenses stay relatively stable contribute towards positive property values.

Now, this can cause an increase in net operating income, which will appreciate property values further. As long as this value is more than the inflation rate, the investor’s investment will not be hampered.

Lease agreements for commercial properties are structured in a way that increases the rents at regular intervals throughout the lease term. An agreement, for example, could have a clause that calls for an increase in the rent at the rate of 2 per cent to 3 per cent annually.

Based on the property and the demand and supply of the market, the clause for different assets will be different. As long as these regular increases outpace the inflation rate, the relative return will stay positive.

Can investing in REITs help against inflation?
REITs provide natural protection against inflation. Real estate rents and values tend to increase when prices do. This supports REIT dividend growth and provides a reliable stream of income even during inflationary periods.

A practical way of measuring the inflation protection provided by REITs is to directly compare REIT dividend growth with inflation. In all but two of the last 20 years, REITs' dividend increases have outpaced global inflation, statistics show.

5. Turn adjustable-rate debt to to fixed-rate instead

Although this is not actually an investment move, it could be a strategy to not just protect your investments from inflation, but also make a profit while doing so.

Periods of low or declining inflation favour adjustable rates over fixed rates when you borrow money. But the dynamic reverses when inflation rises.

Addition debts:
Periods of low or declining inflation favour adjustable rates over fixed rates when you borrow money. But the dynamic reverses when inflation rises.

Higher inflation results in higher interest rates, which means that as inflation accelerates, your adjustable rates will continue to rise — even to potentially unsustainable levels.

So with inflation rising worldwide, you should begin rolling your adjustable-rate overseas debt over to fixed rates. This should include credit cards, home equity lines of credit, and your mortgage.

If you refinance your mortgage, try to lower the repayment period and avoid resetting your 30-year mortgage. You will end up paying a lot less in interest, even if your monthly payments remain the same or are higher.