As you consider what investments to make or whether to divest parts of your portfolio, the effect of inflation on your assets as well as on the economy at large should be a significant factor in your decision-making process. As inflation, well, inflates the cost of living, you need to make sure that your portfolio is earning at least that much to break even. An 8% return sounds good unless inflation is at 10%!
In the past, Richard Cayne has spoken about inflation considerations (http://www.richardcayne.com/richard-cayne-meyer/do-you-really-need-to-be-concerned-about-inflation/). “Inflation and deflation may seem like a simple concept,” Richard explains. “But its impact covers all financial and economic life, so you should always keep tabs on this figure and make sure your assets are protected. Even a slight change in the cost of living can have a substantial effect.”
Inflation is for more than just measuring rising costs
Most economists predict that central banks raising interest rates recently will herald an increase in inflation. But does this just mean that the cost of a cup of coffee will go up? Probably yes, but there’s more to it. Just because the cost of living has been measured as increasing, this does not automatically mean that your wages and other income will increase to match. Unfortunately, this is where the main problem lies.
Not every employer will raise salaries in step with inflation, so you may find that not only will your money buy less, but you may have less money to buy anything period. And unless inflation changes sharply, you probably will not notice any changes right away until you need to make a major expenditure.
So, considering that some sort of inflation increase seems to be lurking around the corner, it would be prudent to reassess your investments to make sure you are protected.
Some investments that can weather inflation
A simple financial instrument to protect yourself against inflation are inflation-indexed bonds. Most of these products are sovereign bonds, such as the United States’ Treasury Inflation-Protected Securities (TIPS) (https://www.treasurydirect.gov/indiv/products/prod_tips_glance.htm) or Canada’s Real Return Bonds (http://www.fin.gc.ca/invest/instru-eng.asp#Government). These instruments will either adjust their principal or interest according to inflation (usually daily rates of that country’s overall consumer price index). Many investors opt for these bonds to not only diversify their portfolio, but also to hedge against inflation – these products are usually guaranteed to return their original value (the interest gained is where the risk lies).
In anticipation of an increased inflation rate, many economists and financial consultants will point to commodities as an appealing investment option. Increased costs mean the price of commodities should rise as well, so basic commodities such as oil, soybeans, and gold should increase in value to meet inflation. However, there are supply and demand factors that will also influence commodity prices.
As a logical progression of this argument, investing in company stocks are also touted as a way to benefit from inflation. Rising costs may mean that companies must spend more, but they can pass this increase to their customers, and then some, so they could increase profit, making equities an attractive investment. But this can also be a simplistic conclusion as sales are not the only factor in a company’s success.
What should you do?
Unfortunately, protecting your investments against inflation requires so much more than number crunching. How an investment instrument will respond to the economy as a whole, including to inflation, is not always easy to predict, and often, past performance will not guarantee future success.
And, even after all this, very few people will track inflation rates until a rise makes the news. So, to discuss these various inflation strategies to figure out your best course of action, contact Richard Cayne at Meyer International.