Inflation is a term that describes the rising prices of goods and services. Basically, it occurs when you spend more on the same items than you did previously.
When everybody is spending more and getting less for it, the economy is impacted negatively. According to Jeanette Garretty, chief economist at Robertson Stephens, “In every economic environment, there are winners and losers and inflation is no exception. However, the longer high inflation persists, the harder it is to find winners.”
How does inflation hurt you, me and the economy?
1. Lower purchasing power
If you can’t buy as many goods and services as you did before inflation, your quality of living will decrease. Obviously, essential spending will be prioritized, while non-essentials take a backseat. Individuals that were already struggling financially will suffer the most during inflation, since their budgets were already stretched and adjustments are harder to make.
2. Loss of value of savings
Inflation makes not only your income, but also any savings you may have accrued less valuable. Unless you are putting money away in a high-interest savings account, expect to lose value as inflation continues. This is because many savings accounts offer a lower return than the rate of inflation, a difference which is easily noticeable over the long-term.
3. Loss of goods and services
Periods of inflation are typically followed by certain businesses being forced to close down as customers eliminate non-essential spending. Anyone operating in such industries will feel the brunt of this loss of business. The result is a struggling economy, characterized by flailing businesses.
How can I invest to hedge against inflation?
Inflation is a natural occurrence in any economy. However, one can dull the more painful effects of inflation by investing strategically. Even so, not all investments can offer protection against inflation. Those that do have the following characteristics:
1. Investments with international exposure
Increasing your international exposure is a good inflation hedge. Invest in funds that allow access to major world economies/indices whose movements do not occur in tandem with Kenyan markets. This hedges your portfolio against domestic economic cycles.
2. High yielding investments
At face value, most investments appear to offer decent returns. However, when the cost of inflation is factored in, it becomes clear that the investor is actually losing value. Therefore, high-yielding investments, whose rate of return is much higher than the rate of inflation is your best bet to preserve the value of your capital. Prefer those that offer long-term compounding values and are linked to tangible, appreciating assets.
3. Choice of assets/asset classes
Historically, some assets and asset classes are better inflation hedges than others. These include equities, real estate, and some commodities such as gold. Therefore, including them in your portfolio will strengthen it against inflation.
Inflation is a reality in all economies. Generally, money will lose value over time and current events will affect the rate of inflation. However, investors are not helpless. By preferring investments that offer international exposure and give a high return as well as choosing assets that are able to withstand inflation, they can preserve their capital’s value regardless of a harsh economic climate.