Over the past two years, economic experts and investors have been concerned about the looming threat of high inflation. It seems like inflation is declining, but it’s still a major force in the financial world. How should investors recognize and adapt to high inflation? And is there anything we can do to prevent such high inflation rates in the future?
What Is Inflation?
In this context, “inflation” refers to price inflation. Though specific definitions sometimes vary, price inflation describes the phenomenon of price increases across various products and industries, typically attributable to a drop in the value of a specific currency.
On a logical level, this makes sense. If the value of a dollar decreases, the spending power of a dollar should proportionally decrease. That means you’ll need to spend more dollars on each product or service you purchase in our economic landscape.
Inflation is a complex phenomenon with many influential variables, but one of the most important variables to recognize is the money supply; when there’s a significant increase in the money supply, the value of money naturally decreases.
As an investor, it’s your job to appropriately manage your purchases and investments to minimize potential losses from inflationary times – and potentially even take advantage of the situation.
How Investors Can Adapt to High Inflation
So how can investors adapt to high inflation?
The value of good debt.
First, it’s important to recognize that good debt can be especially valuable during high inflation. The nominal value of the debt you take on will remain the same while the value of money decreases around you; as a result, you’ll pay less (in weight) when paying off your debt over time. That’s no excuse to max out your credit cards, but if you’re considering purchasing a home or making another major investment with the help of debt, now may be the time to move forward.
The potential of real estate.
For multiple reasons, commercial and residential real estate can be excellent hedges against inflation. For starters, many real estate investors take out loans to buy new properties, allowing them to secure good debt in an inflationary environment. Also, real estate is “real,” physical property, insulating it from some of the more volatile market shifts in the economy. As a bonus, real estate can generate recurring cash flow, helping you remain stable in economically uncertain times.
A new outlook on stocks.
Investing in stocks can also be valuable, but investors should exercise caution. In times of high inflation, certain companies struggle while others thrive. Be sure to prioritize investing in companies resilient to economic volatility and capable of performing even during the worst inflation phases.
The many sides of currency.
Currency investments can work out in your favor if you can accurately predict the course of inflation. The value of the U.S. dollar decreases during inflationary periods, which means it could be a valuable time to invest in other currencies. However, this isn’t a perfect rule, and you should always do your due diligence before moving forward with any currency investment.
Interesting commodity plays.
Certain commodities, like oil and gold, historically perform well during economic instability or high inflation. They could be valuable additions to your portfolio if you research them properly; remember that commodities markets can be highly unpredictable, even for experts in the field.
The importance of portfolio balancing.
There are many investments worth considering in an inflationary period, but no matter what, it’s important to maintain balance. Spend time analyzing the risks and benefits of each asset within your portfolio, and make it a point to rebalance whenever necessary. As you get older, your risk tolerance will shift, gradually making you less tolerant of risky holdings; each year, you should go some of your assets to accommodate for this effect, moving from more difficult, potentially rewarding plays to safer ones. When inflation is near record highs, you should be even more conservative if you’re concerned about potential losses.
The Uncertainty of Inflation
Some economic experts believe that inflation is beginning to ease, though the slowdown will likely be gradual. Other experts believe that inflation is likely to remain high for the foreseeable future because of high consumer spending, money supply increases, and other variables.
No one can reliably predict exactly how inflation will change in the future or when it will return to “normal” levels. Even our best economists are divided, so it’s important to recognize our collective uncertainty. Do your research and make your best judgments when making decisions for your investment portfolio.