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Over the course of the last 18 months, there has been growing talk about the possible rise in inflation. As most people are probably aware, inflation erodes the value of money. Over time, the amount of goods and services we can afford declines when inflation rises; the higher the rate of inflation, the more the value of money falls.
Inflation chatter has increased significantly since the arrival of the pandemic. Two things stand out. First, supply chain constraints mean that inflation for certain key commodities have risen as a result of shortages; timber and computer chips have been two prime examples. But the second is more nuanced, government debt! In many countries, it has simply exploded.
In the past, inflation was used to drive down the real cost of the debt that a government had taken on. Today, while governments have loosely mentioned ‘changes to spending and taxation’, inflation will surely be one of the tools that they will have to consider. And if current governments do not, there is little to stop future ones from doing so (inflation is managed in the Eurozone by the ECB!).
That said, we have some inflation today but overall, it is still relatively muted and a lot of signs currently point to much if it being as a direct result of those short-term supply-chain blockages, let’s hope it remains that way.
But how do you protect your savings (and wealth) from the corrosive impact of inflation? In this article, we will take a quick look at the considerations to managing inflation risk to your investment strategy.
Commodities – certainly, there could be a tempting case for investing in commodities presently as it is here that a lot of price inflation is taking place. However, commodities are highly volatile. Recent lumber price volatility has seen steep rises and falls as demand and supply issues slowly got resolved.
Equities – this is where the real inflation-proofing can take shape. However, it is a minefield and knowing what to buy, hold, sell takes time and a lot of individual effort. To make matters worse, the old rules of buying value, or returns have been upended with a lot of the focus shifting to long-term ‘potential’ and even to a vague form of investment rebellion as has been the case with the surge of so-called ‘meme stocks’ in 2021. However, for many equities, the old rules still apply and to be successful, you must take time to consider the key metrics of the underlying firm, industry etc…plus timing, it is important, especially when it comes to realising gains and limiting losses.
Property – while the property market is red hot presently, it is still a risky bet! First, as an investment, for many people, it represents too much concentrated risk. It also requires significant leverage that can be expensive. Additionally, many governments and municipalities are tightening capital gains rules and tax treatment of ownership and income in an all-out effort to increase the supply of residential property directly to families. This trend is likely to grow, especially where residential units are concerned. For many smaller investors, the squeeze from governments and municipalities can become a major disincentive. However, for those that have the financial resources to invest and full understanding of the changing landscape, it can yield positive returns and some significant capital gains potential.
Managed funds – it is here where the dynamic of a diverse range of investment choice and growth options makes for the most practical inflation-proofing potential. For some funds, average annual growth of 8% – 12% would not be unusual. So far this year, year-on-year growth of 15% – 25% is not uncommon (once the 2020 pandemic stock market crash is factored in). What makes managed funds so interesting is many have exceeded house price inflation yet barely earned a mention in national media when compared to the furore over house price inflation. It is for this very reason that property can be fraught with social, fiscal and other challenges whereas managed funds are not. Plus, depending on how one buys into managed funds, growth potential can be boosted significantly. Doing so via a pension can be the most tax efficient whereas the net income approach via the non-pension option can be much more expensive and less rewarding. However, compared to some of the other options in the market, even factoring for taxes, they can still generate significant growth potential that far outpace current inflation worst-case scenarios.
Bonds – fixed income options are probably not the best inflation proof options in the market as they may prove to be too low.
Cash deposits – it is currently where too much household wealth sits at present earning little more than between 0% and .25%. Even with inflation at one-half (.5%) of a percent, deposits earning .25% are losing money. And it is not just the loss of the value of that money that is a concern, it is also the mix of the cash being unwanted and also, negative interest rates being a real possibility. For example, many credit unions have lowered the amount of cash members can hold on deposit. In some cases, this is resulting in members being instructed to withdraw money. In other cases, banks have informed savers with deposits in excess of specific limits of upcoming charges or negative interest rates. On that basis, the risk to cash deposits is three-fold; inflation, deposit-reduction and negative rates. So, while cash may still be ‘king’, at present, because there is so much of it and because it is so cheap, it is also unwanted.
Finally, a quick word on ‘hype investing’ in the likes of Bitcoin and meme-stocks. There is still no sound argument to migrate away from investing fundamentals. Bitcoin and many of the other so-called crypto-currencies remain speculative gambles. Meme stocks are, in many ways the product of investment revolution. Yes, they make for really interesting stories but when it comes to your money, make sure you follow the basic rules of sound investing: research, plan, be patient, cash-out on reasonable gains, limit losses and pay attention
Frank Conway is the author of Ireland’s Essential Guide to Personal Finance and founder of MoneyWhizz. He works with leading employers on a range of financial wellbeing initiatives.
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