These days, it seems like that’s all we hear about in the news. But what exactly is inflation? Investopedia defines inflation as “the decline of purchasing power of a given currency over time”. Here’s an example that might make it easier to understand.
In 1910, an ounce of gold was worth approximately $20. According to the 1910 catalog of a prominent clothier in New York City, that $20 would buy you a very nice men’s suit. Today, the price of gold is approximately $1800.
If your $20 in 1910 was held in gold, it would have held its value very well— it would also be able to buy a very nice men’s suit in 2022. However, if your $20 was held in cash back then, that $20 would only buy you a pair of dress socks these days. Over time, your $20 has relatively less and less value.
That is inflation in a nutshell. So why does it occur?
There can be several reasons that lead to inflation. Causes of inflation are excess aggregate demand (economic growth that is too fast), cost-push factors (the cost to supply products increases), or an increase in the money supply.
If the demand for a product is high, then its price will go up. Similarly, if the cost to supply, build, or ship a certain product increases, then the price of that product will also increase.
Another reason for inflation is an increase in the supply of money. If more money is put into the pool, and it is not backed by anything of value, the value of the money already in the pool is diluted and subsequently decreases.
These are the textbook explanations of inflation— but what does all of this mean for you and I?
Well, it effectively means that your dollars a year ago can no longer buy what they could back then. On a day-to-day basis, it feels like you have less money than last year.
In reality, you have less purchasing power with the same amount of money. Either way, it sounds terrible, doesn’t it? We work just as hard this year as last year, but it buys us less.
Is there anything we can do about it?
Another buzz word we hear all the time is the word “hedge”. What is a hedge against inflation?
An “inflation hedge” refers to an investment which is made for the purpose of protecting against the decreasing purchasing power of money due to the rising prices of goods and services.
The ideal investments for hedging against inflation are those that will maintain their value during inflation, or that will increase their value over a specific period of time.
Some examples of common inflation hedges are: TIPS (Treasury inflation-protected securities ), floating rate bonds, stocks, gold, and real estate.
The first two examples are U.S. government bonds. Which begs the question: is it just me or does the idea of investing in bonds provided by the government to counteract inflation —which is often caused by the government— seem a bit ironic? This may serve to minimize how much your purchasing power has decreased, but these investments are certainly not effective tools to grow your wealth.
Another potential hedge are stocks. Because stocks represent ownership in a business, this business typically increases revenue during inflationary times. This in turn will cause the stock price to increase. Although they can do a good job of keeping up with inflation, there is quite a bit of volatility in stocks.
In addition to that uncertainty — prior to the beginning of this inflationary time — there was much talk about a market correction and the fact that most stock prices were based on inflated price to earnings ratios. How did they go from risky to a “good idea” in such a short period of time? Great question!
Gold has often been thought of as a great hedge against inflation. The best part about gold is how it holds its value, as I mentioned in the example before. There have been periods in time when the price of gold did not outpace the rate of inflation. But for the most part, it represents a decent choice for most investors.
Lastly, real estate is another popular inflation hedge— specifically commercial property. Unlike the stock market, the value of real property does not swing wildly over a short term period of time. According to Mashvisor.com, “Real estate appreciation is a highly effective hedge against rising prices.” Additionally, they point out that “the appreciation rate of U.S. real estate has been consistently higher than inflation for over a decade now.”
Another interesting concept is the fact that inflation can be both good and bad. From what I’ve described up until now, it’s hard to see how there could be benefits from inflation but there definitely are!
In my next newsletter, I will outline ways we can use inflation to our advantage as investors.
In times like these, I am reminded of what Warren Buffett once said:
It’s important that I make it clear that I’m not giving financial advice. Based on my working knowledge as an investor and the success I’ve been fortunate to find, this is how I plan to protect my wealth against inflation in these coming months. Be sure to practice your due diligence in any investment you put your hard-earned money towards especially in uncertain times like these.
That being said, I believe that the time to act is now. Truthfully, the best time to take action was probably six months to a year ago but as it goes with many things, better late than never.
In the meantime, I’d be happy to provide guidance if you would like to learn more about investing in gold and other precious metals as well as investing in commercial real estate.
Please schedule a call. I would love to discuss this with you.