4 investment tips to beat inflation. Yes, inflation affects your investments

Beating inflation rate is the primary goal for anyone who wishes to increase their wealth. As bank savings cannot hedge against the rate of inflation, everyone is looking for investments to hedge against it and add the surplus to their retirement. Most investors are aware of the typical assets that can keep up with inflation. But most are oblivious to the barriers to the means of inflation protection. Therefore, to optimally beat the rate of inflation, investors ought to know whether their knowledge about inflation is well-grounded.

A simple definition of inflation would be a currency losing its value, and its impact on reality is the rising prices and buyers losing their purchasing power. It generally results from an imbalance in supply and demand in goods but political, and natural disasters can also contribute to inflation. A state's objective is to ensure price stability by keeping the annual inflation rate under 2%, meanwhile encouraging consumer demand to keep the economy functioning.

Inflation rates also affect your investments

While everyone accepts that the value of savings in a bank account will reduce over time, most tend to forget or choose to ignore that inflation also affects investments. The positive side of inflation is that an investor can take advantage of a particular asset class's rising rates. The con of it is that some investments may not generate sufficient income against the unavoidable deductibles, such as income tax and subsequent inflation of the revenue. As an investor, you ought to know the circumstances under which the asset classes are best apt to fight inflation.

Hence, here are 4 investment tips to beat inflation:

1. Choose your investment period: long-term or short-term to hedge against the rate of inflation?

There is a common consensus that fixed-income-based investments perform poorly against inflation. However, such notions tend to ignore investment terms when it comes to proper hedging. Some investments tend to work better in the long run, while others are profitable for shorter periods. Investors need to research well into the periods before deciding.

For example, a TUM study evaluated that Stocks are a good investment against inflation over a long period. This is because stocks' value moves with the prices of the indices. Higher inflation points to higher dividends and thus higher revenue. Future Contracts or Commodity Futures are also excellent long-term investments against inflation longer than three years, and its positive outcome increases with increasing period.

Bonds have a terrible reputation in the investment market due to their decreasing value. Still, studies have shown that Bonds have similar inflation-beating qualities as Stocks in the long run, with the additional benefit of being cost-efficient. The same can be said for gold, which is not popular among investing enthusiasts due to its low returns. Still, studies show that it can hold against inflation in the long run, albeit partially because they depend on the monetary market, i.e. they may be out of fashion for people to use.

Real estate may be the only asset that may support all investment terms, depending on the investor himself. It carries the same inflation-beating characteristics as stocks and brings good revenue for someone investing for a short time. Studies merely confirm the obvious that it beats inflation for both a long-term and short-term investor.

2. Allocate your assets smartly to hedge against inflation

Whichever period you choose for your investment, you still need to consider how you should divide it. Allocating your investment asset is essential in managing your portfolio since it is a deciding factor for your revenues and, ultimately, beating inflation. The critical takeaway from asset allocation is that it should be dynamic, i.e. it should be mixed with different asset classes that balance your returns and risks. Studies show that an excellent way to allocate assets is to have a mix of stocks and bonds with an index in commodities futures (CF) that can balance returns with risks in an inflationary atmosphere. Commodities deal with real assets, unlike stocks, and therefore have a definite correlation with inflation. Their prices move along with inflation, and consequently, they are stable. Oil and production-based indexes, CFs are an excellent hedge option.

Some include real estate in their investments to better balance their portfolio to beat inflation. Since it is a tangible asset that appreciates with time, it is considered a first-class inflation hedge. Investors may choose a residential or commercial estate or both, but real-estate is low in volatility with high returns in both cases. On the other hand, studies show that real estate investment trust (REIT) rrevenues are not correlated with inflation. Hence, investment in equity and mortgage REITs is not safe from it. Once an investor realises these factors, he will go on to allocate his assets smartly and efficiently.

3. Diversify your portfolio efficiently to beat inflation

Diversification is an effective strategy against inflation every investor agrees with, but more than half do not know what it entails. Diversification does not merely mean spreading investment in all types of assets - it means diluting risk by avoiding investing in the same asset class or same risk characteristic. Adequate diversification is more likely to outperform inflation than over-diversifying. Investors must ensure that they prevent over-diversifying by investing in too many assets of the same class or with the same risk characteristics. This portfolio may bring in large profit when the market is pushing the asset class upwards. Still, when the economy crashes, the indices will respond inversely to the same economic event, making this diversification expensive and completely obsolete.

A well-diversified portfolio would have a mix of index funds, exchange-traded funds, stocks and real estate. But this is not the standard rule for investors to follow through no matter what. Investor needs to be proactive and dilute their risks by choosing assets that are less likely to be affected by inflation.

4. Get to know the non-traditional investments

Being an investor means keeping an open mind to all forms of investment vehicles. Do not limit yourself to typical investment types, as there are obstacles within these assets themselves that can bar you from entering the market in the first place. Barriers may include a high minimum capital requirement to invest, or they do not cater to your specific needs (short-term investment, for, e.g. since most typical investments are for long-term). This only pushes you away from protecting yourself from inflation. To get around those difficulties, you may look at some non-traditional investments that have been established, such as P2P lending, cryptocurrency, and crowdfunding. These are unique assets as they integrate financial technology and automation, diversify, balance risks, and keep matters hands-off.

Cryptocurrency has become a multi-billion dollar asset class over the past few years due to its low transaction costs and blockchain use. Peer-to-Peer lending has become popular because they eliminated the middle-man used to get the most out of the arrangement. Companies facilitate the parties who otherwise few options to borrow money and invest money. Investors can choose from loan types, term, and the type of borrowers. There are several well-known P2P lending platforms out there that have provided stable returns for investors between 5% to 30%. Crowdfunding is another kind of investment that has allowed investors to invest in real estate or a business for an affordable capital amount. It enables investors to earn the income on specific assets that they otherwise could not have afforded directly. Crowdfunding has been successful as a capital-raising model over the last 10 years, and it kicked off many businesses that are well-known today. The list is not exhaustive. There are countless variants of investments out there that can help to protect yourself from inflation.

Inflation is unavoidable, and although important, it is not the end goal. Other factors, such as risks, returns, and liquidity, should also be factored in. With the help of fintech platforms, people now have the opportunity to afford measures against inflation.

Last update: 08/03/2021