When inflation occurs, the prices of goods and services go up, making life hard for average individuals. Businesses aren’t left out as well. They, too, bear the brunt of inflation. While inflation is widely known for its effects on the value of money (lowers your purchasing power), there are a few things you can do to protect your finances from inflation and even profit from it.
Here are three common ways to profit from inflation while others count their losses:
- Invest in real estate
- Invest in value stocks
- Invest in commodities
- Invest in TIPS
Inflation reduces your purchasing power and can make life hard for you. To counteract the effects of inflation, you need to know how to make money off it. But is that even possible? Can you make a profit from a situation that makes negatively affects the economy? Of course, you can, and I am about to show you how.
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How to Profit From Inflation?
Do you want to make profits during inflation? If you want to be less worried inflation, you need to know how to make profits at such a difficult time. Below I reveal tips on how to make profits during inflation. Let’s first understand what inflation is.
Inflation is a measure of the rate of increasing prices of goods and services in an economy. If inflation occurs, the prices of basic necessities like food will increase, negatively affecting society.
Inflation can happen in almost any product or service, including need-based expenses like housing, food, medical care, utilities, and want expenses like cosmetics, automobiles, and jewelry. As soon as inflation becomes widespread throughout an economy, the expectation of more inflation becomes a top concern in the consciousness of consumers and businesses alike.
Central banks of developed economies, such as the Federal Reserve in the United States, keep an eye on inflation. The Fed has an inflation target of around 2% and modifies monetary policy to fight inflation if prices increase too quickly.
Inflation can be a huge concern as it makes the money you stash in the bank today less valuable tomorrow. Inflation diminishes customers’ purchasing power and can even hinder your ability to retire peacefully. For instance, if an investor earned 5% from investments in stocks and bonds, but the inflation rate was 3%, the investor only earned 2% in the real terms. Below, we will examine a few things about inflation before moving on to how you can profit from it.
The Basic of Inflation:
In economics, inflation is a quantitative measure, one of quantity over quality, monitoring the rate of change in prices of a standardized basket of goods. Inflation is defined as a rise in prices over time, and the rate of that increase is represented by a percentage.
The most common economic reports used to estimate inflation are the Consumer Price Index (CPI), the Producer Price Index (PPI), and the Personal Consumption Expenditures Price Index. The PCE price index is the Federal Reserve’s preferred inflation gauge. The PCE is a bigger measure than the CPI and is weighted according to consumption measures used to obtain the gross domestic product rather than on a household spending survey like the CPI.
CPI measures the weighted average urban consumers pay for the standardized market basket of goods and services. It is reported monthly by the Bureau of Labor Statistics (BLS).
PPI is a weighted average of prices realized by domestic producers. It includes prices from the first commercial transaction for many products and some services. It is also reported monthly by the BLS.
The PCE Price Index is a wider measure than the CPI of the change in the price of goods and services bought by consumers. It is released monthly by the Bureau of Economic Analysis of the United States Department of Commercial.
Effects of Inflation: How Does It Affect You
The impact of inflation affects several groups when it occurs. However, not all groups are affected the same way. Who benefits from inflation, and who is unlucky?
Generally, in a period of light inflation, job-seekers can benefit. High spending can mean high demand, and companies may choose to hire new workers to keep up with the increased demand. If you have taken a loan from a lender, inflation could be ok for you. With the currency devalued, what you borrowed a few years ago equals a lower amount of money.
In this supposed mild or light inflation, businesses that sell goods and services can benefit also. A healthy amount of inflation is said to boost and encourage spending more; at its best, that can work in a way that the increased costs are cancelled by an increase in sales.
Serious inflation, however, is a cause for concern for almost everyone. If inflation surges too much, people lose trust in their currency. Financial institutions suffer as individuals withdraw their money. Businesses aren’t left out as well. Their goods become costly for most individuals.
People with low income and fixed incomes suffer from inflation. The value of a currency plummets, but income hasn’t necessarily increased. If an individual’s yearly income is just $25,000 and the inflation rate from one year to the next is 2%, that salary is now equal to what $24,500 was the previous year.
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Examples of Inflation:
Inflation often occurs on a month-to-month basis, even if it’s not severe. In fact, during the well-known Great Recession, when unemployment increased, there was a manageable inflation rate of 1.7% in October of 2009.
Hyperinflation, on the flip side, is a much rarer occurrence. However, over the past century, many countries have endured hyperinflation and its terrible consequences. Some common examples of hyperinflation are:
Zimbabwe in the 2000s went through severe hyperinflation. Many economists point to the country’s covering the costs of the second Congo War by printing more money as the main cause of this problem. The inflation was so terrible that the currency became almost useless, and eventually, the country’s plan became to demonetize their currency entirely and adopt foreign fiat currency.
Hungary dealt with a serious hyperinflation issue in 1946, after World War II. At its worst, the inflation rate of the pengo (Hungary’s currency at the period) was more than 200% daily. Prices doubled every 15 hours. Like Zimbabwe, the inflation struck an unfixable point where the only way out was to abandon the currency and start a new one entirely. The country reintroduced the forint, the currency they adopted in the late 1800s, in August 1946.
Germany, after World War I, experienced hyperinflation of the paper mark. The Weimar Republic lost the war, and the country had to create many hard currencies so that they could settle the huge debts incurred from the funds they loaned to finance the war. The mark lost its value significantly and borderline became worthless.
How to Protect Yourself from Inflation?
When inflation hits, you’ll definitely want to protect yourself from its effects. But how do you do that? The most powerful way to shield yourself from inflation is to raise your earning ability and income, if possible. A 5% annual raise, or a promotion that nets you a 20% gain, would make inflation less important. You’ll have to look at other options if that’s impossible or if you are on a fixed income.
One of the best ways to protect your savings is to invest in the stock market. It boasts of a return of approximately 10% of investments over time. But whether it will do so later on is unknown, and there is a risk attached to investing in the stock market.
How Central Banks Manage Inflation?
Central banks worldwide use monetary policy to prevent inflation and deflation. In the U.S., the Federal Reserve aims for a target inflation rate of 2% year-over-year.
The FOMC announced on August 27, 2020, that it would allow a target inflation rate of over 2% if that would help boost employment. It still seeks a 2% inflation in the future but is ready to allow higher rates if inflation has been low for some time, as seen in the October 2021 rate.
The feds use the core inflation rates that remove energy and food prices. These prices are set by commodities traders and are too volatile to consider.
How Inflation Affects Asset Values?
While inflation’s effects on the economy and asset values are up in the air, history and economics offer some general rules.
Inflation is most damaging to the value of fixed-rate debt securities, as it devalues interest rate payments, including repayments of principal. If the inflation rate surpasses the interest rate, lenders are, in effect, losing money after adjusting for inflation. This is why investors sometimes concentrate on the real interest rate, gotten by deducting the inflation rate from the nominal interest rate.
Longer-term fixed-rate debt is more prone to inflation than short-term debt, as the effect of inflation on the value of future payments is more and increases over time. The assets that perform well under inflation are those that are bound to generate more cash or rise in value as inflation rises. Examples would include a rental property subject to periodic increases in rent or an energy pipeline charging rates associated with inflation.
Sectors That Benefit From Inflation
Profiting from Inflation:
People are often apprehensive of inflation. But did you know that you can profit from inflation even with surging prices?
- Real estate
Single-family homes financed with low, fixed-rate mortgages often perform excellently during inflation. As inflation rises, your property is likely to appreciate in value while the monthly service cost of your mortgage stays constant. This is at the very heart of building home equity, which can rapidly boost your wealth.
By buying real estate, you are also protecting yourself from increasing rents. Like any other consumable good, rent tends to increase during inflation. Even though mortgages are less flexible than rental agreements, they have a perk when inflation is at its apogee.
- Value stocks
Some research has indicated that value stocks tend to perform well than growth stocks during periods of inflation. Value stocks are companies that have robust earnings relative to their current share price. They are also known for strong cash flows, which investors typically value when prices increase.
On the flip side, growth stocks tend to be more sensitive to changes in interest rates, a common monetary policy reaction to inflation. Over the past decade, when inflation has been missing, growth stocks enjoyed a period of success. However, recently, value sticks have staged a comeback. The current environment makes their progressive success probable.
- Commodities
Commodities include gold and other precious metals, including raw materials and various natural resources key to production. Simply put, as demand rises, prices increase in the economy, and the cost of production to meet that demand typically increases in lockstep.
Commodities are generally seen as safe-havens for assets during times of unpredictability. While commodities don’t pay dividends or represent any underlying business, they are uncorrelated to the traditional asset classes of stocks and bonds and move in an unrelated direction.
- TIPS
TIPS, or treasury inflation Protected Securities, are marketable U.S. Treasury securities aimed at solving purchasing power erosion. TIPS has the advantage of periodic inflation modifications, a characteristic that standard fixed-rate bonds don’t have.
Investors looking for capital preservation and purchasing power stability should look at TIPS as part of their lower-risk portfolio segment. TIPS holders can enjoy the confidence that their principal would be returned to them, given that TIPS are supported by the full faith and credit of the United States Government.
