Most people understand that inflation increases the price of their groceries or decreases the value of the naira in their wallet. In reality, inflation affects all areas of the economy and over time, it can take a bite out of investment returns.
Understanding the relationship between inflation and investments is essential to making informed investing decisions.
Inflation is an economy-wide, sustained trend of increasing prices from one year to the next. The rate of inflation represents how quickly investments lose their real value and how quickly prices increase over time. Inflation also tells investors exactly how much of a return (in percentage terms) their investments need to make for them to maintain their standard of living.
Speaking an Entrepreneurship & Business Management expert, Dr. Timi Olubiyi said, “considerably, institutions, businesses, and individuals have the opportunity to beat inflation by accelerating the preservation of capital and strengthening purchasing power with income addition.
“This can be done by acquiring investments particularly assets such as real estate because they usually keep up with inflation. Remember N1 million today will not acquire the same value of investments, goods and services in five years mainly due to inflation. Therefore, investing is key to hedge against a sharp inflation impact because it erodes the value of savings if funds are just left in the bank accounts.”
Olubiyi explained that “supportively, it is imperative to consider investing in other currencies, diversify your investment portfolio internationally if you can, consider inflation-protected securities with potential for higher-growth like equities, Gold Shares ETF, or mutual funds.”
The chief executive officer, Sofunix Investment and Communications, Mr. Olusola Oni, said an investor that has a long-term view can use stocks to hedge against inflation.
According to Oni, stocks tend to grow in value in the long term while holding a diversified portfolio such as 60/40(Stock/Bond) has potential to protect an investor from declining purchasing power. Value stocks, inflation-protected bonds, and real estate are silver bullets that attack inflation.
A value stock refers to companies whose shares trade below intrinsic value otherwise called undervalued stocks, he said.
How To Profit From Inflation
Here are inflation hedges that can help keep investors afloat as prices rise:
Real estate; By purchasing real estate, you are also insulating yourself from rising rents. Like any other consumable good, rents tend to rise during inflation surges. Even though mortgages are less flexible than rental agreements, they have an advantage when inflation is high.
Value stocks; Some research has shown that value stocks tend to do better than growth stocks during periods of inflation. Value stocks are companies that have strong earnings relative to their current share price. They are also known to have robust cash flows, which investors typically value when prices are rising.
Growth stocks; Over the past decade, when inflation has been conspicuously absent, growth stocks enjoyed a banner period. But lately, value stocks have staged a comeback. The current environment makes their continued success likely.
Commodities; Commodities include gold and other precious metals, as well as raw materials and various natural resources critical to production. They are generally seen as safe-haven assets during times of uncertainty.
Treasury Inflation Protected Securities (TIPS): They have the advantage of periodic inflation adjustments, a characteristic that standard fixed-rate bonds lack. Investors seeking capital preservation and purchasing power stability should take a look at TIPS as part of their lower-risk portfolio segment.
I-Bonds; Like TIPS, they offer a nearly guaranteed return of principal. Given that many investments are likely to lose real value during inflationary periods, it makes sense to think of other options beyond stocks that stand a chance of keeping pace.
Overall, one of the best ways to combat inflation is to consistently ensure that we are properly diversified and fully invested. Money invested in stocks tends to outpace inflation in the long run, while positions in real estate, commodities, TIPS or I-bonds can only serve as further diversified protection.
Cash on the sidelines is guaranteed to lose value, while long-term bonds will be impacted if interest rates begin to rise.
In general, inflationary periods present the opportunity to revisit your financial situation and make adjustments for what may lie ahead.
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