How to Protect Your Money During Inflation?
All of us are aware of the fact that a unit of currency that could buy a number of things some 20 years back can barely be used to buy one such thing in the current times. Why does this happen? The reason is inflation. It is considered the biggest enemy of the purchasing power of money. However, on the other hand, inflation is also seen as a good sign of a growing economy. But the very first effect of inflation, that is, loss of purchasing power, troubles people a lot as no one wants to be in possession of something whose value is degrading over time. So, how can you protect your money during inflation? Here are a few things that can help you.
What is Inflation?
Inflation refers to the reduction in the purchasing power of money. The quantitative calculation of inflation is done by considering the increase in the average prices of basic goods and services over the given period of time in the economy. This indicates that the scope of goods and services which can be bought by a unit of money right now is lesser when compared to the amount which could be bought with the same unit of money in the past.
Inflation occurs when the government starts printing more money and hence, devalues its legal tender currency. Sometimes, the government does this by loaning new kinds of money in the market. There are mainly three types of inflation, that is, demand-pull inflation, cost-push inflation, and built-in inflation that drive the reduction in purchasing power of the money.
What Happens When Inflation Hits?
Inflation affects various aspects of society and the economy in different ways. It’s also the viewpoints of people that make them consider inflation as both, a sign of a booming economy and a sign of a struggling economy. Here are some common effects of inflation.
Lowers the Purchasing Power
When the prices of a basket of goods and services increase, it is known as inflation as the purchasing power of the legal tender currency is decreasing. The basket of goods and services consists of the basic commodities which are irreplaceable in human life like food, fossil fuels, etc.
Encourage Investments and Purchases
When the inflation period begins, people tend to invest their money excessively to buy out things and stock them up before the value of currency reduces further. They tend to buy assets that are likely to remain the same in terms of value even after the inflation period.
Potential for More Inflation
When something is decreasing in terms of value, every person holding the asset wishes to get rid of it before its value depreciates further. So there is a higher supply against a limited or no demand. This, in turn, reduces the value of the asset as no one wants to buy it. The same goes for money and inflation. During inflation, when the purchasing power of money decreases, people want to spend the cash before its value depreciates. This increases the flow of cash in the market against very low demand. This leads to further loss of purchasing power of money.
As people begin investing and spending their money during the inflation period, the economy of the country grows on account of an increased flow of money in the market.
How to Protect Your Money During Inflation?
As stated above, the purchasing power of money weakens during inflation. Now that your money is slowly degrading in value, how do you protect your money during inflation? How do you ensure that your money exists in the form of assets that won’t depreciate in value? Even if they do, how do you ensure that it will bounce back to its original value at the end of the inflation period? Here are some assets to help protect your money during inflation.
5 Assets to Protect Your Money Against Inflation
Here are five assets that you can invest in to protect your money against inflation.
There has been a history of gold acting as a currency when the native currency of the countries lost its value. Gold provides a perfect hedge against inflation because it holds some real value. While gold may not pay any yields or instant dividends, it surely increases in value over time.
Real Estate Investment Trusts
Real Estate Investment Trusts are basically companies that deal in real estate which can produce income. This concept is based on the fact that the prices of property and rental income increase whenever there is a rise in the inflation rates. These trusts pay out dividends to their investors.
Leveraged loans are a category of loans where the borrower company is the one having a very low credit score and high levels of debts. Since there is a very high risk of loans going default, the borrower company has to pay a very high-interest rate for it. Collateralized Loan Obligations are a special asset class in the category of leveraged loans. Here, multiple loans come together to create single security. As there is a floating rate yield in these assets, they help in hedging your portfolio against inflation.
The S&P 500 gives you a clear picture of how the stocks of certain companies have been performing so far. Experts believe that inflation periods benefit businesses that need very little capital to operate. On the other hand, the companies that require very large capital are inflation losers. At present, the S&P 500 majorly consists of technology and communication-based companies so they are inflation winners. In contrast to this, the companies dealing in natural resources become inflation losers.
Commodities such as oil, precious metals, fuel, electricity, grains, and so on have a certain relationship with the inflation rates. Whenever there is a rise in the prices of these commodities, the prices of their by-products also increase, giving a clear indication of inflation. Thanks to the various ways of investing in commodities, like ETFs, people can easily invest. It also helps in protecting their money during inflation. One must note here that the trading of the commodities requires very high caution. It is because the slightest change in uncontrollable factors like geopolitical conditions can severely affect their prices.
TIPS is a short form for Treasury Inflation-Protected Securities. These are government bonds that mimic the increase and decrease in the inflation rates. So, when inflation increases, the interest rates increase as well. Similarly, when the inflation rates drop, the interest rates also fall down. Making TIPS investments helps in balancing your portfolio as they work in line with the Consumer Index Prices.