- Inflation can eat away at one’s returns if the investments do not consider the level of inflation in an economy.
- Real assets, high growth investments, and variable-interest instruments are the type of investments that can offer real returns instead of nominal returns.
- Some of the inflation-proof investments include gold, commodities, REITs, dividend-paying and growth stocks, geographic diversification, and TIPS.
Inflation measures the level of price rise over a given time duration. Investors may find themselves in a tight spot when prices are rising as inflation would eat away at the returns offered by the investment. The nominal returns offered by an investment might be increasing. However, the real returns would be lower due to inflation.
Thus, investors prefer inflation-proof methods of investment or those investments which benefit from inflation. However, it is essential to note that returns are not guaranteed anywhere when an investment is made. At best, inflation-proof investments could provide safety against rising price levels.
Before considering such investment options, here are certain inflation-related aspects to consider.
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Inflation and types of investments
For inflation-proof returns, investments must have certain characteristics that allow investors to enjoy real returns. Some of these include:
- High growth investments: Investors must focus on instruments that can offer high growth other than simple income. Fixed income assets are generally the worst-hit assets during inflation. If the returns are growing at par or above the rising prices, investors can enjoy some level of security against the price rise.
- Real investments: Nominal assets are bound to be hurt under inflationary pressures. Assets like a Certificate of Deposit or traditional bonds are priced based on the fixed returns offered by them. Real assets are tangible and hold an inherent value. Thus, as commodity prices are rising, the prices of these physical assets are also likely to shoot up. Investors can hold some amount of their investments as physical or real assets.
- Variable-interest assets: Unlike fixed interest assets, variable-interest assets can be more useful in an inflationary environment. Interest rates may also rise with inflation, giving the investor a chance to recuperate his losses.
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Investments to turn to during inflation
Gold is considered a hedge against inflation. Gold has been used as a medium of exchange in old times, and it continues to be an asset of interest due to its intrinsic value. Unlike fiat money, gold holds an inherent value that makes it attractive to investors. When the domestic currency is losing value, gold is also used as an alternative.
Investing in gold not just means buying a physical asset. Gold derivatives are also a standard method through which some level hedging can be done against rising prices. Individuals can buy shares and bonds in gold. Digital gold is soon gaining recognition among investors physical delivery can easily take place. Additionally, gold is a highly liquid asset and can be easily converted into cash.
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One can invest in commodities like oil, electricity, natural gas, and precious metals to make use of rising prices. Just like gold, the price of these commodities rises with increasing inflation. Metals like silver and copper are also commodities worth looking at.
Many of these commodities are seen as an indicator of rising prices. An important factor to consider in commodity trading is the impact of underlying demand and supply of the commodity. Factors of demand and supply make commodity prices as well as the prices of their derivatives volatile.
Real Estate Investment Trusts (REITs)
Investing in property during inflation can be a clever way to secure profits. Often property prices skyrocket under inflationary pressures and are highly reflective of the real value of the assets in the market. REITs gather pooled sums of money, invest those in property and pay out dividends to their investors.
The dividends paid out by the REITs are subject to taxation. Thus, investors must be wary of the level of taxation and how much returns would be achieved. REITs allow investors to invest as per their affordability.
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Dividend-paying and growth stocks
Dividend paying stocks can be a refuge for investors in stressful times. If investors are losing out on their investment gains due to inflation, dividend stocks give them an opportunity to lock in additional income. If the yield is higher than the annual inflation rate, then investor can obtain higher real returns.
Growth stocks can also be a good option to invest in. Generally, when prices of commodities are rising, companies are also able to draw in higher profits. While input costs are also rising, some stocks can outperform the industry average. These stocks are known as growth stocks, and they are generally issued by companies engaged in technology or medicine. These companies can lock in higher profits due to new products or techniques developed by them.
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It is possible that only the domestic stock market is adversely affected by the inflation. However, international markets are not affected as badly. It is a good idea to invest in foreign stocks or international bonds to lock in profits in such a case.
Treasury Inflation-Protected Securities (TIPS)
TIPS are issued by the US Government and are inflation-indexed securities. This means that their returns move in sync with the level of inflation in the market. This keeps investors secured from inflationary pressures eating away at the value of their investments.
The principal value if TIPS increases as inflation rises, which is measured through CPI. However, TIPS may offer lower interest than other securities and government bodies. These returns are government-backed and are thus, considered secure.
Thus, it is possible to obtain gains from the market even when the market is down. Investors must make wise decisions depending on the market scenario.
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