The US inflation rate has been skyrocketing and currently is over 7%.
Inflation is when prices for everything from apples to zoo tickets go up. As prices rise each dollar buys less stuff, or in economic terms purchasing power declines.
This means that while the amount of money you have stays the same, everyday items increase in cost.
Early in my business career, I created a financial plan with a man that was raised in Peru. When discussing potential growth rates and inflation estimates for his financial plan, he laughed at the modest inflation rate I projected.
He explained that when he was growing up in Peru he saw runaway inflation with his money-losing value daily at an alarming rate. I could understand his skepticism at my relatively modest projection and shared the U.S. historical inflation rate to comfort him.
Interest rates have been steadily declining since 1982 and inflation has followed suit. For most US investors, few have seen inflation or a rising interest environment, including me.
I have talked to many people though that remember having mortgage interest rates in the mid to high teens.
Reasons for inflation include:
- Oil production policies
- Government spending
- Covid-related supply chain slowdowns
- Plain old market cyclicality
- Russian aggression
No matter what the cause, the question remains…
What To Do About Inflation
Inflation creates a real challenge. Keeping money in cash or cash-related investments just erodes purchasing power.
You have to have your money in something that has the potential for appreciation, but investing in things other than cash-related investments carries risk. Many people have a tendency to want to avoid risk (for a good reason).
Below I list out some of the investment options we all have to defend ourselves from inflation.
Government Inflation Bonds Or I Bonds.
This is probably the safest investment to keep pace with inflation. It adjusts to the government’s inflation rate index. The problem is you have to buy them from treasurydirect.gov and you are limited to $10,000 per person, per year.
Also, your money will only keep pace with inflation, it does not stay ahead of it. Still a better option than cash.
Annuities Or Insurance Products.
Annuities can provide guaranteed income and in some cases give you stock index-like returns with principal guarantees. These products can be useful but come with higher internal costs or participation rates and can have challenging surrender costs and taxation features.
Investing In Bonds:
A bond is a loan to a government or business. They take your money upfront and agree to pay you a certain percentage each year then give the money back in the end. When loaning to reputable companies bonds are often secure investments, but they don’t always beat inflation. Also, just like a bank CD charges you a fee to get your money back early, getting out of a bond early may require discounting the value when interest rates are rising.
This is considered the world’s largest asset class.
The great thing about real estate is that the owner of a property will generate cash flow from tenants paying them, and also the value of the property is likely to increase over time. The downside, as every homeowner knows, is that owning property is a lot of work.
Products like Real Estate Investment Trusts allow you to own property without the work, but the included property management can be very expensive and you have less control over where and when the property is bought and sold.
Commodities are the trading of fungible resources. The quality of these resources has no regard to who produces them.
Oil, precious metals, food, and livestock are examples of commodities that are traded on the NASDAQ. Trading commodities directly is complicated due to the storage of real goods (how would you even keep a cow in your 401k?).
However, many commodities can be indirectly invested in through various funds and have historically kept pace with inflation despite short-term fluctuations in prices.
A stock is an ownership of a company. Before computers, investors would receive a piece of paper, much like the deed to a house, saying they were owners of a small piece of a company. As an owner, you have a right to vote on the actions the company will take, you may receive payouts called a dividend when the company is profitable, and your piece of the company becomes more or less valuable as the company does more or less business.
Stocks have historically been the best performing asset class but they can be volatile during periods of inflation. The upside is stock is easy to buy and sell and most firms have zero trade costs these days.
Metals are a type of commodity, the classic example of which is gold, which people have used as money, or as a store of money for thousands of years. Historically, this backing of money with gold made it a good protection from inflation as it could only change value as more gold entered or exited the local market.
However, since the world departed from the gold standard this is no longer necessarily the case.
Other metals can be used as a physical store of value, but more often than not their value is tied to the relative demand from companies for use in industry or technology. The problem with metals is that there are no balance sheets, profit & loss statements, earnings forecasts, or dividends. Its value is only moved by consumer sentiment.
The most volatile asset class of them all. Yes, decentralized financing might become the future, but in the meantime, it is incredibly volatile making it a risky investment.
Look at this graph from Investopedia to understand what I am saying:
Here’s another graph from the S&P 500.
A lot more stable!
Like the many things that have contributed to our inflationary problem, The solution is likely a combination of many different things to help overcome the effects of inflation and to manage or spread out the related risk.
Inflation Is The Hidden Tax
Economists have long known that inflation is functionally equivalent to a direct tax on cash holdings. That means when we have a 5% inflation rate for a year, it has the same effect on your life as if the government wrote you a tax bill for $5 for every $100 you have in your bank, in your wallet, or even under your mattress!
While some small inflation (usually estimated at 2%) is normal, quickly adjusted to, and arguably even healthy for the economy, higher inflation can cause massive problems. Unfortunately, in the last few years, the federal reserve has printed $4.64 trillion dollars, and now our inflation rate is over 7%.
The worst part about this hidden tax is that it applies to everyone rich or poor, young or old, corporation or individual.
The best part of this tax is that it only applies to cash holdings, not other investments.
Excellent Investment Portfolios To Combat Inflation
The good news for you is that we have a portfolio specifically designed to perform during this time period of high inflation.
Our heritage portfolio is a combination of 10% S&P 500 Options, and 90% U.S. Treasury Bills. This allows for market comparable returns with a smaller amount of risk.
Options contracts are inherently risky but can provide great returns which is why we put 10% of capital into this portfolio option. As for the other 90% in U.S. Treasury Bills, we select several maturity dates with our bills, and most of them are short-term.
This portfolio was designed to compete against inflation.
What Does It All Come Down To?
Whenever inflation gets out of control, the economy is set to fall apart. Look back at the late ’70s and countries like Venezuela, Zimbabwe, and Germany post-WWI that had out-of-control inflation rates.
The time to prepare for inflation is now, and WealthGuard Advisors is knowledgeable and qualified to help you navigate your investment options and build a plan to ensure you don’t lose your hard-earned wealth to inflation.
And if you have any questions about anything finance-related, reach out!