Inflation is a rise in the prices of goods, due to which the purchasing power of money falls. Typically, inflation is a few percent a year, but it devalues capital appreciably over the years. For capital to increase annually, the investor must ensure a return on investment above the current price level. Let’s look at several popular investment strategies and compare their potential.
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Run Away from Cash and Toward Equities
Among the several options, an investor must make to combat inflation, maybe the most excellent advice is the simplest to implement. Maintain an equity position.
It is clear and honest advice. When a business’s costs go up, it may simply raise prices to make up for them, which means more money and profit. A good thing for both the company and the person who invests in it. It is the perfect inflation hedge for someone who wants to keep their money in the right places.
Investors who are worried about inflation may want to invest a few more percentage points of their portfolio in stocks to ease their fears. Keep in mind that we said this inflationary era is short-lived; if prices fall, investors can simply unwind this extra allocation.
As a side note, keep in mind that this time around, savings rates aren’t going up as much because of inflation. This is different from when there was a lot of inflation in the past when savings rates rose along with interest rates. Investors who are in the equities market can earn more money over time, which means they have more money to buy things.
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Tilt in the Direction of Floating Rates
A well-balanced portfolio should have most of its fixed income exposure in high-quality bonds. However, limited income returns have been flat to negative in this market. This appears to be a losing struggle for investors seeking to ward against inflation.
This is how it might work: One part could be a hedge. This is called a bond fund that changes its rate. This investment can be used to give a portfolio a “tactical tilt,” which can be very important in a time when prices rise. Investors, on the other hand, need to know how these funds work.
If a business borrows money from a bank, it usually gets a variable-rate loan. Credit-wise, the loans are called “senior debt,” which means that they get paid first over other investments, like high-yield bonds.
However, when prices rise, the interest rate on these bonds goes up. This makes them unusual in a strong inflationary environment. When investors put these bonds into a portfolio, they may be able to fight the negative effects of inflation on their other bonds. A tilt of between 3% and 5% is good enough.
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Commodities Can Be Beneficial
Also, investors can trade commodities, which is a tried and true way to make money. During times of high inflation, commodity prices tend to go up, which means that investors can make money from the increased demand for these assets.
Making a commodity allocation is all about having a wide range of options. If you invest in a commodities fund, it will help to lessen some of the risks that comes with it. As with variable rate bonds, a tilt is more than enough to act as a hedge against rising prices.
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Inflation Could Be Temporary or Permanent
American people have been very lucky to enjoy low inflation for a long time because of technological progress, globalization, and lower inflationary expectations. However, the Covid-19 outbreak has caused a lot of damage.
While we are in this “transitory” phase, it is important to keep a laser-like focus on the parts of portfolio creation. This is the best way for an investor to deal with the changes that are taking place in the market now.
