The Impact of Inflation on your Investments: Strategies for Preserving Wealth
Inflation is inevitable and happens in countries all around the world; at a different percentage. One of the major setbacks of inflation is the effect it has on investments and how it can negatively influence financial planning.
This blog has two parts mainly; the first one discusses the negative impacts you can expect after your country is hit with inflation and in the second part, we shall wealth preservation and the investment strategies ideal for you during such economic times.
How Inflation effects Investments
A significant decrease in Purchasing Power
Even if the value of your investments /assets remains the same over time, inflation is likely to decrease its purchasing power which means that the same amount will be of less value and thus, its ability to purchase goods will drop. This is inflation’s basic and the most damaging affect as it harms the economy as well. In order to keep up with the inflation, the returns of your investment have to keep up with the inflation or its real value will decrease too.
Increasing Interest Rates
Inflation also might have a direct effect on the interest rates because when this happens banks want to control the spike. In order to compensate for the existing money losing its value, banks increase the interest rates and also discourage borrowing and spending by doing so. Same is the scenario with private lenders who increase interest rates so make up for the value their lent money would have lost by the time they get the amount back.
Dropping Stock Prices
Inflations eventually tarnishes the stock market which is bad news for most companies as well as the people who have invested in the shares. Inflation causes instability in the economy which leads people to alter their purchasing patterns. This causes profits of most companies to come directly under fire. During such uncertain times, investors may not feel too sure about the future of their investments and hastily sell their stocks at low prices instead of holding them and bearing loss.
Increase in Commodity Prices
The rise in prices of commodities usually indicate rising inflation. While it may not be favorable for the consumer base of those commodities, inflation might work in the favor of the people who have invested in this sector.
Basically, the challenge while investing during inflation is to keep your investments safe from the economic crisis as much as possible. Only when one has a complete knowhow regarding the impact of inflation on their financial planning can they decide their strategies accordingly. A well-planned investment strategy primarily aims to alleviate the risks of inflation.
Below are some investment strategies that you need to adopt if you are planning to invest during inflation that will help you reach your goal of wealth preservation.
Strategies for Preserving Wealth
Investing in Appreciating Assets
While investing in most of the industries might be risky in times of inflation, there are some sectors which pay back even during tough financial times. Investing in such areas is an excellent investment strategy to make sure that the investments keep up with the inflation rates. For instance, one is likely to benefit from investments in commodities, in real estate or buying gold which is bound to appreciate with time. Investing in such appreciating assets is a great inflation hedge.
Maintaining a Diverse Investment Portfolio
An investment portfolio is made up of a variety of investments of various types. It consists of investments belonging to different asset classes such as stocks, bonds, real estate investments and even cash. A good investment portfolio also has investments done across a vast geographical area. As a result, your investments are safe from inflation or a downfall of a certain industry. Moreover, all your investments won’t get affected from a financial crisis in a single country. This investment strategy basically suggests the investors to ‘not put all their eggs in one basket’.
Invest in Treasury Inflation-Protected Security
Treasury Inflation-Protected Security (TIPS) is a certain type of treasury bond which is protected from inflation. The value of these bonds is directly proportionate to inflation and its value increases with inflation; however, the amount of interest might change with the updated value of the bond. This bond gives the investors a security of never losing the purchasing power of their bonds due to inflation.
Invest in Foreign Currencies
Investing in foreign countries is one of the most adopted investing strategies and the most sought after inflation hedge. Buying foreign currencies will keep your investments safe from inflation in the home country. If one owns a certain amount of foreign currency, local inflation would not decrease the purchasing power of that amount but might in fact result in a profit. This inflation hedge is not a stable means of earning profit but better to keep your investment safe.
Invest in a Tax-Deferred Savings Plan
Tax-deferred savings plan is a tax advantaged account which is tax free as long as long as the amount is being accumulated in the account. Having this account allows the account holder to be able to defer tax payments until the investment is withdrawn which usually happens after retirement.
Do not hold cash unnecessarily
Holding liquid money can be extremely risky during inflation and long term time frames. In both these circumstances, it is recommended to not have cash but invest it in a suitable investment plan instead, in order to prevent the amount from losing its purchasing power. Investing the amount will not only keep the value stable but might earn a return on it.
There can be many ways to gauge the risks involved in investing during inflation, many investing strategies to consider and several inflation hedges to create; it is always recommended to do a full research of that plan is suits your specific financial goals over the time. Moreover, one can always take help from financial advisors or investment consultants to plan ahead and understand the market better.
Why Stocks fall during inflationary environment
High inflation times can have a significant impact on the stock market. Investors often become anxious during times of inflation as it directly affects the economy and the overall value of their investments. As a result, many investors tend to sell their stocks, leading to a decline in stock prices.
The primary reason why stocks fall during high inflation times is that inflation erodes the value of money. Inflation makes it more expensive to buy goods and services, leading to a decrease in consumer spending. As consumer spending declines, companies experience a decrease in revenue, which negatively affects their stock prices. When investors see that companies are making less money, they often sell their stocks, further driving down prices.
Moreover, inflation can cause the government to increase interest rates, which can lead to higher borrowing costs for companies. When companies borrow at higher rates, it can reduce their profitability and make it more difficult for them to expand their operations. This can further impact their stock prices.
Additionally, during times of high inflation, central banks tend to tighten monetary policy. This is done to reduce inflation and stabilize the economy. However, the tightening of monetary policy can have a negative impact on the stock market as it reduces liquidity in the market, making it harder for investors to buy and sell stocks.
In conclusion, stocks fall during high inflation times because inflation erodes the value of money, leads to a decrease in consumer spending, increases borrowing costs for companies, and can lead to tighter monetary policy. These factors can negatively impact companies and their stock prices. As an investor, it is crucial to understand the impact of inflation on the stock market and take appropriate measures to protect your investments. Diversifying your portfolio, investing in inflation-protected securities, and seeking the advice of a financial advisor can help you navigate the challenges of investing during high inflation times.