How to protect your money from inflation?

Inflation is the common name that everybody hears every time in their life. But most people fail to act accordingly. Many people treat inflation as less important as they strictly believe that inflation and its consequences have a mild effect on them. According to the calculations, the inflation rate in the USA is about 3.8% per year taking the average from 1960 to 2022. but in the year 2022 itself, inflation was at a rate of around 6.5%

Here, I am giving the 10-year inflation rate chart for your reference:

*This data is up to only 2023 June 7.

Now you can see how much the inflation rate has shot up.

Why is inflation so high recently?

The global market has faced a great increase in the inflation rate from 2021 on. Actually, this started in the middle of 2021 and is mainly due to the Covid-19 pandemic and the subsequent economic dislocation along with supply chain problems. United Nations FAO(Food and Agricultural Organisation) said that the food prices in 2022 have reached the highest level in the last decade. This is so the worst situation that you will really wonder on comparing it to the 2020s food prices. The reports given by FAO show it to be almost a 30% increase.

Anyway, now in 2023, the inflation rate has been decreasing to reach the normal level. The international monetary fund says that the inflation rate would return to the target only by 2025 (read). And still, we cannot be so sure about any other adversities that could come. So the only way is not to get afraid about your money, but it’s time to think how you can protect it from inflation and likewise, make use of inflation to make some money. Believe me, this post will give you a perspective.

Ways to protect your money from Inflation

This section will give you proper ideas about how to protect your money from inflation.

Can stock investment protect money from inflation

This is what most people seem intuitively simple but actually not the correct way. Most everyone says that stock investment can give you quite more returns annually on comparing to the banks’ various schemes and thereby nullifying the effect of inflation. For example, if the inflation rate is 6% annually and your shares show an annual capital appreciation of 10%, then you will get a 4% growth to your invested money on considering its value.

Yeah, this is simple logic and the maths goes quite well. But all we are lacking is the common sense.

Benjamin Graham, well-known as the father of value investing, in his book The Intelligent Investor, points out this very thing.

The logic goes something like this: when inflation suddenly increases, it’s possible that the stock prices may also fall down considerably as the company also buys raw materials at a higher cost and sells their own product at a higher rate causing the customer to be unable to buy the products, which eventually reflects in the companies profit.

This is not the case with common stable inflation rates but sudden erupts can definitely do.

On taking the 2021 case, we can see it pretty well. As the inflation rate started hiking suddenly by mid-2021, the value of stocks started declining.

Suppose you are a man who strongly believes that stock investment is a wise option to protect your money from inflation. When the inflation rates started getting violent in the mid-2021s, you started thinking of investing your money in the stock market as soon as possible. Then you found the S&P 500 index good to go with as you can’t take much of a risk.

And what did happen at last?

From 2022 onwards the stock started declining as you can see from the chart below. Still, in the year 2023, your investment seems to book a loss. The loss along with inflation makes your money less worthwhile. In this scenario, not doing anything (ie: letting your money be there in your pocket as it is) seems less foolishness than investing in stocks.

So investing in stocks is not considered the wise option for protecting your money.

Remember: under normal inflation levels, stocks do really great to beat inflation. Historically, stocks and real assets like real estate and commodities have shown the potential to outpace inflation over the long term. The things I’ve mentioned are only the case when inflation heats up to higher levels.

Can investing in bonds protect us from inflation?

Fixed-income securities are not usually preferred for fighting against inflation. As bonds are also fixed-income securities, the matter is not different here too. But there are certain variants of bonds that can really come as a helping hand from the depth of inflation. TIPS by the US government is such a security.

What is TIPS?

TIPS stands for Treasury Inflation-Protected Securities. TIPS bonds are a type of investment issued by the U.S. Department of the Treasury. They are specifically designed to help protect investors from the effects of inflation.

Here’s how TIPS bonds work:

1. Inflation Protection: Unlike traditional bonds, the principal value of TIPS bonds adjusts with inflation. This means that as the cost of living, or the general level of prices in the economy, increases, the principal value of the bond increases as well. This adjustment is based on changes in the Consumer Price Index (CPI), which measures inflation.
2. Fixed Interest Payments: TIPS bonds pay interest semi-annually based on a fixed interest rate. The interest rate remains constant throughout the life of the bond. However, the actual interest payments you receive may vary because the interest is calculated based on the adjusted principal value of the bond.
3. Adjusted Principal Value: The principal value of TIPS bonds is adjusted for inflation. This means that as inflation rises, the principal value of the bond increases, and as inflation falls, the principal value decreases. At maturity, you receive either the adjusted principal value or the original principal value, whichever is greater.
4. Deflation Protection: If there is deflation (a decrease in the overall level of prices) during the holding period of TIPS bonds, the principal value can decrease. However, the U.S. Treasury guarantees that you will never receive less than the original principal value at maturity.
5. Income and Taxes: While the principal value of TIPS bonds adjusts with inflation, the interest payments are subject to federal income tax. However, you can defer taxes on the inflation adjustment until the bond matures or you sell it.

TIPS bonds are considered a relatively low-risk investment because they are backed by the U.S. government. They can be a valuable addition to an investment portfolio for individuals seeking protection against inflation or looking for a stable income stream. However, it’s important to note that TIPS bonds may have lower yields compared to traditional bonds due to the inflation protection they offer.

Investors should carefully consider their investment objectives and consult with a financial advisor to determine if TIPS bonds are suitable for their individual circumstances and investment goals.

Is investing in REIT good?

A REIT, which stands for Real Estate Investment Trust, is a way for people to invest in real estate without actually buying properties themselves. It’s like a company that owns and manages different types of real estate, such as apartments, office buildings, shopping malls, or hotels.

When you invest in a REIT, you’re essentially buying shares, similar to stocks, in that company. The money you invest is pooled together with other investors’ money, and the REIT uses that money to buy and manage real estate properties. The profits generated from these properties are then distributed back to the investors as dividends.

One of the key benefits of investing in a REIT is that it allows you to have a share in the real estate market without the need for a large amount of money or the responsibilities of property management. You can start with a relatively small investment and still benefit from the potential income and growth of the real estate market.

REITs are required by law to distribute a significant portion of their income to shareholders, usually at least 90%. This means that investors can receive regular dividends, which can be an attractive feature for those seeking steady income from their investments.

There are different types of REITs that focus on specific sectors of the real estate market, such as residential, commercial, or industrial properties. This allows investors to choose the type of real estate they want to invest in based on their preferences and investment goals.

It’s important to note that investing in a REIT does come with risks. The value of your investment can go up or down depending on various factors, such as the performance of the real estate market and the specific properties owned by the REIT. It’s always a good idea to do your research and consider your investment goals and risk tolerance before investing in a REIT or any other type of investment.

How REIT investment beats inflation?

Investing in REITs can potentially help beat inflation for a few reasons:

1. Income Generation: REITs often generate income from the rent collected on the properties they own and manage. As inflation occurs, rental prices tend to increase over time. This means that the income generated by the REIT can also increase, providing a potential hedge against inflation. The dividends paid out to investors can be adjusted to reflect these rental increases, which can help protect against the eroding purchasing power caused by inflation.
2. Property Value Appreciation: In addition to rental income, the value of the real estate properties owned by the REIT can appreciate over time. As inflation rises, the cost of constructing new properties tends to increase, making existing properties more valuable. This appreciation in property values can positively impact the value of the REIT shares and provide a potential source of capital gains for investors.
3. Diversification: Investing in REITs can provide diversification benefits to a portfolio. Real estate tends to have a low correlation with other asset classes like stocks and bonds. Including REITs in an investment portfolio, helps spread the risk across different asset types. Inflation can impact various sectors of the economy differently, and having exposure to real estate through REITs can help mitigate the effects of inflation on the overall portfolio.
4. Inflation-Adjusted Leases: Some commercial real estate leases have provisions that allow for periodic rent increases based on inflation. These leases are often structured as “escalation clauses” or “inflation-adjusted leases.” REITs that own commercial properties with such leases can benefit from inflationary pressures, as the rental income adjusts to keep pace with inflation.

How to make use of inflation?

Throughout this entire article, I picturized inflation as a true villain. But this is the time I want to open up the helping hand inflation offer if you are wise enough to utilize it.

Trading: Trading is not affected by inflation. We can create income through trading even if it is the time of a strong market down or up.

Paying off debts: You can pay off your bank or other debts with the dollars that have been cheapened by inflation. Inflation erodes the purchasing power of money, but it can also erode the real value of debt over time. If you have fixed-rate debt, such as a mortgage or student loan, the nominal value of your debt remains the same, but the impact of inflation reduces its real value. This means that over time, as wages and prices increase, the debt burden becomes relatively smaller. However, it’s important to manage debt responsibly and consider factors like interest rates and your ability to repay.

In real estate trade: how much of the people around you considers inflation? You can make use of other people’s lack of knowledge as a tool in real estate trading. You can buy properties from those kinds of people for a lesser amount and sell them for a higher amount.

Common Q&A about inflation

why does inflation occur?

Inflation is a phenomenon characterized by a sustained increase in the general price level of goods and services in an economy over time. There are several factors that can contribute to the occurrence of inflation:

1. Demand-Pull Inflation: This type of inflation occurs when aggregate demand in an economy exceeds the available supply of goods and services. When demand is high, consumers are willing to pay more for goods, leading to an increase in prices.
2. Cost-Push Inflation: Cost-push inflation arises when the production costs for goods and services increase. Factors such as rising wages, raw material prices, or taxes can lead to higher production costs. To maintain their profit margins, businesses may pass on these increased costs to consumers in the form of higher prices.
3. Monetary Factors: Changes in the money supply can also contribute to inflation. If the money supply grows faster than the rate of economic output, it can lead to an excess of money chasing a limited supply of goods and services. This excess money can drive up prices.
4. Expectations: Inflation expectations play a significant role in determining actual inflation. If individuals, businesses, and investors anticipate higher future prices, they may adjust their behavior accordingly. For instance, workers may demand higher wages, and businesses may raise prices in anticipation of future cost increases. These actions can create a self-fulfilling prophecy, causing inflation to occur.
5. Government Policies: Government actions, such as fiscal and monetary policies, can impact inflation. Expansionary fiscal policies, such as increased government spending or tax cuts, can boost aggregate demand and potentially lead to inflation. Similarly, expansionary monetary policies, such as lowering interest rates or increasing the money supply, can stimulate economic activity but may also contribute to inflation.

It’s important to note that moderate inflation can be considered a normal feature of a healthy economy, as it provides an incentive for spending and investment. However, high or unstable inflation can have adverse effects on purchasing power, savings, and economic stability. Central banks and governments often employ various policies to manage and control inflation within a desired range

Why is inflation so high sometimes?

There can be several reasons why inflation may be high in a particular economy. Here are some possible factors that can contribute to high inflation:

1. Excessive Money Supply: If the central bank of a country increases the money supply at a rapid pace, it can lead to an excess of money in the economy. When there is more money available, it can drive up demand for goods and services, which can result in higher prices and inflation.
2. Demand-Supply Imbalances: When there is a significant disparity between the demand and supply of goods and services, it can lead to inflation. If demand outpaces supply, businesses may raise prices to capitalize on the increased demand. Factors such as population growth, increased government spending, or supply disruptions can contribute to demand-supply imbalances.
3. Cost-Push Factors: High inflation can also be driven by cost-push factors, where the cost of production for goods and services rises significantly. For example, if the prices of raw materials, energy, or labor increase substantially, businesses may pass on these higher costs to consumers in the form of higher prices.
4. Currency Depreciation: If the value of a country’s currency declines relative to other currencies, it can lead to higher import costs. This is because imported goods become more expensive when the domestic currency weakens, which can result in higher prices for consumers.
5. Inflation Expectations: Expectations about future inflation can influence current inflation rates. If individuals and businesses anticipate higher inflation in the future, they may adjust their behavior accordingly. For instance, workers may demand higher wages, and businesses may increase prices, leading to a self-fulfilling prophecy of higher inflation.
6. External Factors: Global economic conditions and geopolitical events can impact inflation rates. Factors such as changes in global commodity prices, trade disruptions, or political instability can have inflationary effects on an economy.

It’s important to note that the specific causes of high inflation can vary across different countries and time periods. Governments and central banks employ various tools and policies, such as adjusting interest rates, managing money supply, and implementing fiscal measures, to control inflation and maintain price stability.

Why is inflation bad?

Inflation can have both positive and negative effects on an economy, but high or unstable inflation is generally considered undesirable due to the following reasons:

1. Reduced Purchasing Power: When prices rise at a faster rate than wages or income, the purchasing power of individuals and households diminishes. This means that the same amount of money can buy fewer goods and services, leading to a decrease in the standard of living. This can particularly impact fixed-income earners, retirees, and low-income individuals.
2. Uncertainty and Planning Challenges: High inflation makes it difficult for individuals and businesses to plan for the future. When prices are rising rapidly, it becomes challenging to accurately forecast costs, profits, and returns on investments. Uncertainty about future prices can hinder long-term economic planning and discourage investment and savings.
3. Distorted Price Signals: Inflation can distort price signals in the economy, making it harder for consumers and businesses to make informed decisions. When prices are changing rapidly, it becomes difficult to differentiate between temporary price fluctuations and underlying changes in supply and demand. This can lead to misallocations of resources and inefficiencies in the economy.
4. Income Redistribution: Inflation can impact different groups within society unevenly. Debtors may benefit from inflation as the value of their debts erodes over time. However, savers and creditors suffer as the real value of their savings or loans decreases. High inflation can exacerbate wealth inequalities and create winners and losers within the economy.
5. Reduced Consumer and Business Confidence: High or unstable inflation erodes confidence in the economy. Consumers may delay purchases in anticipation of further price increases, leading to a decline in consumer spending. Businesses may hesitate to invest and expand due to uncertainty about future costs and profits. This can result in reduced economic activity and slower economic growth.
6. Negative Impacts on Fixed-Income Assets: High inflation can erode the value of fixed-income assets, such as bonds and savings accounts. If the rate of inflation surpasses the returns earned on these assets, the real value of investments can decline. This can have detrimental effects on retirees and individuals who rely on fixed-income investments for their livelihood.

Why is there inflation?

Inflation occurs due to a variety of factors that affect the supply and demand dynamics within an economy. Here are some key reasons why inflation can occur:

1. Increase in Aggregate Demand: When the total demand for goods and services in an economy exceeds the available supply, it can lead to inflation. Increased consumer spending, investment, or government expenditure can boost aggregate demand and put upward pressure on prices.
2. Supply Constraints: If there are limitations in the production capacity or availability of key resources, such as labor, raw materials, or energy, it can restrict the supply of goods and services. When supply struggles to keep pace with demand, prices tend to rise.
3. Cost-Push: Rising production costs can also contribute to inflation. Factors such as increased wages, higher raw material prices, or elevated taxes can lead to higher costs for businesses. To maintain their profit margins, businesses may pass on these increased costs to consumers in the form of higher prices.
4. Monetary Factors: Changes in the money supply can impact inflation. If the money supply grows faster than the rate of economic output, it can result in excess money chasing a limited supply of goods and services. This excess liquidity can drive up prices.
5. Inflation Expectations: Expectations of future inflation can influence current inflation. If individuals, businesses, and investors anticipate higher future prices, they may adjust their behavior accordingly. For instance, workers may demand higher wages, and businesses may raise prices in anticipation of future cost increases. These actions can contribute to inflationary pressures.
6. External Factors: Global events and trends can also affect inflation in an economy. Changes in global commodity prices, trade disruptions, or fluctuations in currency exchange rates can impact the prices of imported goods and influence domestic inflation.

Why do interest rates lower inflation?

Raising interest rates is one of the tools commonly used by central banks to control inflation. Increasing interest rates can have the following effects that help lower inflation:

1. Reducing Aggregate Demand: When interest rates rise, borrowing costs for consumers and businesses increase. Higher borrowing costs discourage borrowing and spending, which, in turn, reduces overall aggregate demand in the economy. With lower demand, businesses have less pricing power, and competition can exert downward pressure on prices, mitigating inflationary pressures.
2. Curbing Excessive Borrowing and Spending: Higher interest rates make borrowing more expensive, which can discourage excessive borrowing and spending. This helps prevent the economy from overheating and can rein in inflationary pressures stemming from excessive consumer spending or investment.
3. Encouraging Saving: Higher interest rates make saving more attractive by providing higher returns on savings deposits and other interest-bearing instruments. Increased saving reduces the amount of money available for spending and can help moderate demand, thus mitigating inflationary pressures.
4. Strengthening the Currency: Raising interest rates can make a country’s currency more attractive to investors seeking higher returns. As a result, demand for the currency increases, leading to an appreciation in its value relative to other currencies. A stronger currency can reduce the cost of imports, including raw materials and finished goods, which can help alleviate inflationary pressures.
5. Managing Inflation Expectations: By raising interest rates, central banks can send a signal to the market that they are committed to controlling inflation. This can help anchor inflation expectations and influence the behavior of consumers, businesses, and financial institutions. When inflation expectations are well-anchored, it can reduce the likelihood of price increases and contribute to overall price stability.

It’s important to note that the effectiveness of interest rate adjustments in controlling inflation may depend on various factors, including the specific economic conditions and the transmission mechanisms in a given country. Central banks carefully assess these factors and use a combination of monetary policy tools to achieve their inflation targets and maintain price stability

why is inflation good

While high or unstable inflation can have negative consequences, moderate and controlled inflation can be considered beneficial for several reasons:

1. Promotes Economic Growth: Mild inflation can stimulate economic activity and encourage spending. When people expect prices to rise gradually, they may be more inclined to make purchases and invest their money rather than hold onto cash. This increased spending can stimulate demand, boost production, and fuel economic growth.
2. Encourages Investment: Inflation can create an incentive for individuals and businesses to invest their money rather than keeping it idle. When the value of money erodes over time due to inflation, investing in productive assets, such as stocks, real estate, or businesses, can provide a potential hedge against inflation and preserve purchasing power.
3. Reduces the Impact of Debt: Inflation can help reduce the real burden of debt. As prices rise, the nominal value of debts remains the same, but the actual value of the debt decreases in real terms. This can benefit borrowers who can repay their debts with “cheaper” money, effectively reducing their financial obligations.
4. Facilitates Price Adjustments: Inflation allows prices to adjust and reflect changing market conditions. In a dynamic economy, relative prices need to change to reflect changes in production costs, supply and demand imbalances, and technological advancements. Inflation provides flexibility for prices to adjust upwards, enabling businesses to adapt and allocate resources efficiently.
5. Helps Avoid Deflationary Spiral: Deflation, the opposite of inflation, is characterized by a persistent decline in prices. Deflation can lead to reduced consumer spending, as people delay purchases in anticipation of further price declines. This can cause a downward spiral of reduced demand, lower production, and job losses. Moderate inflation helps prevent deflation and maintains a healthier economic environment.
6. Facilitates Monetary Policy: Central banks often target a moderate level of inflation as part of their monetary policy. Inflation allows central banks to adjust interest rates more effectively. By raising or lowering interest rates, central banks can influence borrowing costs, investment, and consumer spending, thus managing economic growth and stability.

It’s worth noting that the benefits of inflation are contingent upon it being moderate, stable, and predictable.