I’m following up on the article I wrote yesterday that covered some facts on inflation. I’d like to preface this post by saying that we’re in a good place right now: inflation is not a threat to us today with it being under control. But it remains noticeable to us in some respects, such as when we note that gasoline and energy prices readjust upward, or when commute costs steadily climb. So it’s just natural for us to want to keep up or outpace these changes.
Inflation is tame today, but its effects sneak up on you after a long period of time (like grey hair and extra pounds). With the purchasing power of the dollar eroding gradually with time, we count on our work incomes to make up for this. But what happens when we retire from stable jobs sometime in the distant future?
What can we do to cushion ourselves from the impact of inflation in the long term?
I found this quote from the Wikipedia quite telling:
Inflation is also viewed as a hidden risk pressure that provides an incentive for those with savings to invest them, rather than have the purchasing power of those savings erode through inflation.
In my mind, there are a couple of strategies we can implement to protect our finances accordingly:
Two General Strategies To Beat Inflation
- Recognizing that inflation erodes purchasing power in the long run. You can make sure you are well invested for the long term so that the performance of your investments more than make up for any kind of inflationary effect that our money experiences throughout the years.
- Being mindful of when inflation rates rise. You can monitor inflation rates, recognize upward inflationary pressures and capitalize on these changes as it happens.
Let’s take a look at these plans in more detail.
Insure Yourself From Inflation For The Long Term
#1 Buy a house.
If you buy a house today, you are automatically hedged for inflation. Your house is a fixed asset and any kind of fixed asset becomes more valuable with time thanks to all around asset inflation.
#2 Consider landlording.
If you invest in real estate today and become a landlord, you’ll be happy to know that rents are subject to inflationary pressures as well. You have the capability to raise rates when the cost of living goes up everywhere.
#3 Build or preserve your earning power.
If you are in a position to earn, the best way to battle pricing increases is to keep a job or some other income stream going. You then expect wages and earnings to go up along with everything else. Without earning power, you may want to consider other ways to protect yourself from inflation, such as amassing appreciating assets.
#4 Own your own business.
Once you’re a business owner you can always raise rates, fees, prices along with the costs of operating your business. This is yet another reason to escape corporate serfdom.
#5 Keep a diversified investment portfolio.
Keep a core portfolio of stocks and bonds, and if you’re a bit more adventurous, you can reserve a small amount of your portfolio to inflationary hedges such as precious metals, commodities and real estate.
#6 Consider using inflation-indexed securities in your portfolio.
You want insurance from inflation? Then try TIPs and I-Bonds, which are types of bonds that offer inflation protection. Some good points about these investments: even in the case of a deflationary environment, you still receive the face value of the bond while interest rates keep at zero or higher; these bonds do not correlate with typical asset classes like stocks and bonds, so they offer diversification; and they pay out more when inflation rises. For details on TIPs and I-Bonds, check these great resources: Morningstar, Andrew Tobias, MSN Money, Motley Fool and Wisebread.
Here’s a helpful table that compares TIPs and I-Bonds.
You can buy TIPs from the Treasury Department at TreasuryDirect.gov, Vanguard (VIPSX), Pimco and TIAA-CREF Inflation-Linked Bond (TCILX). While you can purchase I-Bonds at the Treasury Department as well.
Counteract Inflationary Pressures With Additional Moves
Once inflation creeps up, it could spell bad news for stocks and bonds. So here are a few, more anticipatory (or even reactionary) strategies to counteract inflation’s effect on your portfolio.
#1 Keep money in short term funds.
When there are inflationary concerns, it may be best to keep your money in short term accounts where you don’t lock in rates. This is because higher inflation rates are soon followed by higher interest rates as well. Keep you options open at this time.
#2 Watch interest and yield rates and lock them in when you’re comfortable.
When inflation trends are higher, interest rates typically follow suit. To this day, I have family who were “lucky” enough to lock in sky-high interest rates with long term high-yield CDs when rates were so much higher.
#3 Invest in commodities.
Buying commodities is a traditional inflationary hedge. If you’ve somehow decided that commodities aren’t your thing during periods of tame inflation, you’re not alone. But you may want to reconsider this unconventional asset class once inflationary pressures increase.
You can check out PIMCO Real Return Commodities Fund (PCRIX) which invests in a variety of commodities, or those that track the Dow Jones AIG Commodity Index, which invests only 35 percent to 40 percent in energy such as Deutsche Bank Commodity Tracking Index (DBC). MONEY Magazine also recommends the T. Rowe Price New Era (PRNEX) mutual fund as a good inflation hedge.
#4 Invest in gold.
How about gold? It’s no secret that gold has had a spotty performance throughout history. This is because it may be considered more as a “crisis hedge” rather than an investment. During peace-time, gold has had weak returns. At any rate, if you want true crisis insurance, you can buy gold through these avenues: as gold bullion and coins, exchange traded funds, stocks, mutual funds and even jewelry.
#5 Rework your debt.
When you carry debt, you benefit from a rise in inflation since the value of owed money is worth less over time. So you actually get a break if you carry a bunch of debt such as school and car loans, home equity loans and such. For instance, if inflation rates leapt by several percentage points, any money you’ve borrowed in the past would be worth less than the money you borrow at current rates so by trading any variable-rate debt such as credit card debt or home equity lines of credit) for fixed-rate debt, you’ll actually benefit from an environment with higher inflation.
#6 Cut your spending even more.
This should be the simplest advice but may be the hardest to follow: think hard before you buy anything. Practice abstinence: when items are priced higher, you’ll be spending more, so try every excuse you can to avoid making purchases. Or change your shopping habits so you buy at lower cost places.
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