Introduction
It is a rather complex issue to explain and sometimes very difficult to get your mind around, but it is a thing to comprehend when running your investments. Inflation is the rate of change of the prevailing price level of a number of goods and services and the decline of the purchasing power of money. Inflation rate is a force that runs throughout the financial world yearning our investments not to be immune to it. In this article, we will discuss how inflation affects your investments and how you can steer clear of getting left behind.
1. The import of this paper therefore is to help investors comprehend the effects of such a condition.
Capital investment is generally done in the present with the belief of getting back a value after some time. However, the rate of return is sure not the only criterion which can be used for a decisive choice between different investments. Created by schedule A in 1997, inflation decreases the dollar amount and consequently the value of money resultant with lower purchasing power on the investment returns. For example, if inflation is 3 and while you earn 5 return on investment in one year your real return would be only 2 per cent – because 3 is your freedom to buy.
This will come as a shocker to many, but you will find that inflation does affect various types of investments in their returns. For instance, investing in bonds and fixed-income securities are normally characterised by decline in value when there is high inflation. This is so because in attempt to rein in inflation, such central banks seek to increase the interest rates through operations in the bond markets consequently depressing their prices. Investments on the stocks and the equity markets on the other hand are known to do fairly well during inflationary conditions in that firms can pass on their cost to consumers through the inflation affected prices.
2. Ways On How to Counter Current Inflation
While it is impossible to completely shield your investments from the impact of inflation, there are several strategies you can adopt to mitigate its effects:
a. Invest In A Range Of Investment Instruments
Of all the principles of investment management, diversification is considered to be the most important. Effect of inflation can be minimized if you invest in different classes, sectors and various geographical locations. For example, if a rising inflation is causing the price of stocks to fall on bonds, invest in the stocks that performed well during inflation.
b. Exchange for inflation protected securities.
Inflation indexed securities include TIPS or Series I Savings Bonds that help investors hedge against inflation. For example, TIPS’ principal is Indexed, meaning its adjustment is done in accordance with Consumer price Index (CPI) which is measure of inflation. When inflation rises this leads to the principal going up and the investor then obtains a return calculated as the difference between initial yield and yield after maturity.
b. Reinvest Your Dividends and Capital Gains.
Another strategy you can use to help you beat inflation rates is dividend and capital gains reinvestment. This means that through compounding, you are adding to your investment kitty without necessarily making further deposit to the portfolio. Altogether, inflation can also be addressed as by investing for a long-term, this effect helps to offset the cost of inflation on investments.
d. Opt for Growth Investments
Investment such as Stocks or an Equity Mutual Fund are Equity investments and tend to grow faster than inflation in long run. What this means is that your investment returns have better odds over time of providing for or even surpassing the necessary inflation rate. Of course, growth investments are generally considered to be riskier than income investments; however, this type of investment tends to pay out large returns especially if you have a long-time horizon.
e. How to Integralize Real Assets into Your Investment Strategy
Investment in real assets like real estate or commodities, gold, silver, etc have time and again been seen to perform as the inflation hedge. Most of these assets appreciate during inflation and this means protecting yourself against eroding of the purchasing power in case of high inflation. Nonetheless, investing in real assets may be less straightforward especially if one is to consider its risk and returns factors when it is to be put into the portfolio.
f. You need to be keen on how long it takes for your investment to reach the intended goal.
It is memorable that the investment period you have influences the best course to take so as to counter inflation. For example, if you are investing for a long-term, you can withstand more risk and invest only in the growth investments. On the other hand, if you have a relatively lower investment time period, then you may require a more stabilized strategy likely being involved in profit preservation and steady earnings production.
g. Track your investments and your asset allocation, and don’t be scared of going through your portfolio frequently.
The rate of inflation is never constant; therefore, fluctuations will affect your quality of investments every now and then. Therefore, in order to combat inflation, you need to study the outcome of your investment portfolio from time to time and make some changes. This can take the form of taking measures such as repositioning, restructuring or changing their investment portfolio view to show the current market outlooks.
Conclusion
Inflation is a tough opponent you are going to have when it comes to handling your investments. But if you consider its effects and use the proper approaches, you can outcompete it and save your purchasing capacity. Some strategies which minimize the impact that inflation has on the investor securities are buying of deflation adjusted securities, investment time frame, use of real assets, focusing on investment time frame, reinvestment of dividends and capital gains, and ongoing review and rebalancing of portfolios. When implemented these strategies help to bring a secure financial future for you and your family.
