As of this month the Consumer Price Index (CPI) is running at 7.5% annually. This is the highest rate of inflation the U.S. has seen in over 40 years. Needless to say, many investors are very worried.
How does one invest when inflation is spinning out of control? Historically what has been a good way to reduce the pain of inflation?
Stocks
Many people are surprised to learn that stocks are actually a pretty good hedge against inflation. This is because most companies can simply raise their prices when their input prices go up. As their prices increase, so does their revenue. As their revenue increases, so does their stock price. Over time stocks will keep pace with inflation. The problems occur when inflation leads to a recession and a general downturn in corporate profits.
Treasury Inflation Protected Securities (TIPS)
TIPS are becoming much more popular now that inflation is the highest it has been in decades. These Treasury bonds will pay a yield plus the lagging annual rate of inflation as measured by the CPI. Currently the yield is negative, which means investors won’t quite get the inflation rate. But compare that to the 10 year Treasury bond that has a yield of just 2%, which is 5.5% under the inflation rate and you’re doing much better by investing in TIPS when inflation is this high.
Be careful with taxation on TIPS though. Not only is the yield taxed at your full income tax rate, but so is the amount you receive for inflation. It is usually better to hold these in a tax-deferred account such as a traditional IRA.
Real estate
Real estate is an asset that can be seen and touched. In other words, it is tangible and it is worth something. Because of these qualities, real estate generally moves with at least the inflation rate. This means it is a good hedge against high inflation. Over many years, the growth in real estate investments will almost always be at least as high as inflation.
Get out of cash
Do you have money under your mattress? What about in a bank account or a money market account? Get your money out of there if you can. A year of 7.5% inflation just reduced the purchasing power of that money by the same amount because banks and money markets essentially have a 0% yield. At the very least put the money into a short-term bond fund that earns a yield.
Build a financial and retirement plan
It’s hard to get one’s arms around just how bad inflation might be for their future plans. That is why it is so important to build a retirement plan or have a financial planner do it for you. Once you have a plan in place you can run scenarios to see how varying levels of inflation might impact when you can retire. It can also help you make decisions as to how you should invest your money and how much you need to save. Lastly, by seeing how much you need to beat inflation over time you can make better decisions on spending today.
Create a budget
Nearly everybody should have a budget and stick to it. Now is a great time to start if you don’t have one already. By having a budget you can see which items have gone up in price the most and you can cut back in those areas. For example, you might see that your Netflix subscription has gone up by 20% for the year and you realize you barely even watch Netflix any more. You might want to cancel it. Perhaps you have a bunch of apps on your phone that renew and you didn’t even know it. You can find these and cancel many of them.
You also want to break down grocery items by food category. For example, meat prices have increased by more than vegetable prices. So you might want to cut back on meat purchases, especially higher priced items like steak.
Having a budget will also help you stick to a plan so you can continue to save for the future.
Postpone large spending
It’s easier said than done, but this is what some people have to do during periods of high inflation. That big trip might have to wait another year or two. Or maybe you continue driving an older car and wait before buying another one. Home renovations might have to wait as well since there is a shortage of qualified labor and construction prices have increased dramatically.
Keep saving
Through all of these crazy times we have been living in, the one consistent thing that has helped so many people is that they kept saving money. Saving to a tax-deferred retirement account is the best way to build a nest egg and beat inflation over the long run. Whatever you do, don’t cut back on those 401(k) or IRA contributions.
By following some of these ideas you will be ahead of the curve and will come out of this high period of inflation just fine.
Story by Umair Asif
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