Economic disruptors such as supply and demand are the primary drivers of inflation. Inflation occurs when the supply of money outpaces the available goods and services in the market.
During the 2020 pandemic, governments worldwide injected excess currency into the economy without a corresponding increase in the production of goods and services due to lockdowns. This flood of money into the economy created an imbalance between the money supply and the goods available. Ultimately this has led to an increase in prices, driving the inflation, we see today.
Inflation, often dubbed the “money killer,” highlights the shifting value of money over time. Savvy investors recognize; that a dollar today won’t stretch as far tomorrow due to inflation. As economic events influence inflation levels, it’s important to use effective investment strategies to hedge against its impact. In this article, we discuss the dynamics of inflation and investment strategies to protect your wealth from its erosive effects.
The Impact of Inflation
Inflation can significantly impact daily life by exerting its influence across various expenses. From groceries to housing, and even transportation costs like fuel, its broad reach extends to many aspects of daily life. This widespread effect can directly influence the affordability of necessities, crucial for maintaining a comfortable lifestyle.
At the heart of inflation lies the erosion of purchasing power. This reduction creates a higher cost of living, placing added strain on household finances, especially when salaries do not rise to match the increased expenses.
What is Deflation
Deflation is the opposite of inflation, where consumer and asset prices decline over time, increasing purchasing power. Unlike inflation, deflation can boost consumer spending as goods and services become more affordable, leading to economic growth and stability. However, continuous decreases in pricing may also lead to a decrease in profits and wages, potentially causing economic downturns. Rapid deflation can be associated with a short-term contraction of economic activity and is rare. Deflation typically serves as a positive aspect of a thriving, expanding economy, indicative of technological advancements, greater abundance, and elevated standards of living.
Inflation Erosion of Money
Inflation is often a characteristic of economies experiencing or recovering from economic turbulence. From January 2020 to January 2024, consumer price inflation soared by 19.6%, indicating a notable uptick in prices. For instance, if you spent $100 on a particular grocery list in 2020, today, that same list would cost approximately $120.49.
Over the span of three decades, from 1989 to 2019, the average annual inflation rate stood at 2.5%. However, in just the last four years, this rate has nearly doubled, averaging 4.9% annually. Such a significant increase has led to hardship for many individuals, contributing to the erosion of wealth creation.
Inflation’s Impact on Wealth Creation
Inflation’s impact on long-term wealth creation is staggering. At the forefront of inflation is the erosion of the dollar. Your salary acquired in 2019 may have felt significant in the current state of the economy, however without a pay bump to match the inflation rate for the last four years, this same salary would inherently become 20% less valuable today, due to inflation. Individuals should ensure that their salaries keep pace with inflation; otherwise, they lose buying power.
Similarly, investors should aim for returns on investments that at least match the inflation rate. Otherwise, their investments may be losing value, even if their dollar value increases. This is because inflation gradually diminishes the value of the dollar, thereby reducing the real return on investment over time.
How does the Government Offset Inflation
Government monetary and fiscal policies play a crucial role in influencing inflation. Interest rates, for instance, are a key tool utilized by central banks to manage inflation. Increasing interest rates can curb economic activity, but it also strengthens the currency. This is why we have seen an unprecedented increase in interest rates in the last 36 months as the government has worked towards curbing inflation.
Government spending is another factor. Excessive spending can drive up budget deficits, leading to more money in circulation, which in turn can fuel inflation. Additionally, the money supply, governed by central bank policies, has a direct impact on inflationary pressures, as it influences the availability of money in the economy. Therefore, careful management of these policies is essential to maintaining stable inflation levels and overall economic health.
Government’s Influence on Inflation
An illustrative case of inflation’s impact on the economy can be observed in Turkey. According to the Turkish Statistical Institute, inflation surged to a 25-year peak of 85.5% in October, although many analysts suggest the actual rate may be even higher.
During periods of rapid economic growth, central banks typically employ interest rate hikes to temper the economy’s pace, as seen in the U.S. This is achieved by raising the cost of borrowing, thereby minimizing economic activity. However, in Turkey, the situation has taken a different turn. The Turkish Central Bank has opted to maintain exceptionally low interest rates, resulting in a destabilization of the economy.
The Impact
The persistence of low interest rates can largely be attributed to President Recep Tayyip Erdogan’s unconventional approach to monetary policy. In the past, Erdogan has bolstered his electoral success by flooding the economy with cheap credit. However, if public sentiment continues to decline and economic policies remain unchanged, the prospects for his government may appear bleak.
Navigating Inflation
Preserving buying power amidst inflation is a fundamental principle for safeguarding investments in a volatile market. One of the most significant mistakes investors make is sitting idle during inflationary periods. Proactively addressing inflation by reallocating investments toward assets less susceptible to its effects is a vital strategy. By diversifying into asset classes resilient to inflation, investors can mitigate the risk of erosion and potentially capitalize on asset appreciation to grow their wealth.
The Impact of Inflation on the Housing Market
The housing market is grappling with inflationary pressures across various fronts, such as elevated material and labor costs, coupled with increasing interest rates and mortgage expenses,” explains Sid Vaidya, Chief Investment Strategist for U.S. Wealth at TD Wealth. “These factors have significantly impacted affordability,” he adds.
While rising rates have made the single-family housing market unattainable for some buyers, it has increased the demand for Multifamily housing.
How to Use Real Estate to Hedge Against Inflation
Real estate is often hailed as a recession-proof asset class, known for its resilience during economic downturns. In times of inflation, property prices and rental income typically tend to rise, making investment in multifamily real estate particularly attractive. One key advantage of investing in a multifamily syndication deal is the steady cash flow it generates, as sponsors own and manage income-producing properties. This income stream provides investors with additional monthly earnings.
Another benefit of multifamily property investments is they appreciate over time. This appreciation can yield significant profits upon the property’s sale. Additionally, due to the typical hold period of multifamily investments (usually 3-5 years), they tend to weather high inflationary periods effectively, allowing for economic rebound by the time of exit.
The Bottom Line
Navigating inflation can be perplexing. In times of high inflation, it’s not uncommon for individuals to witness a rise in their income, yet paradoxically, experience a decline in their overall wealth. This phenomenon is seen from the erosion of the dollar’s value over time, where what was once worth a certain amount gradually diminishes in purchasing power.
Investors need to strategize how to position their assets effectively to counteract the erosive effects of inflation and build wealth amidst a depreciating currency. The key is to ensure that investment returns surpass the prevailing inflation rate. By achieving returns that outpace inflation, investors can safeguard their purchasing power and continue to grow their wealth even as the value of money depreciates over time. This approach is critical for successful investing.
Hedge Against Inflation
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