What is inflation?
Inflation is the term used for general price rises in the economy. It is the rate at which, on a general basis, the prices of goods and services rise. Deflation, on the other hand, is the rate at which prices and services fall.
Central banks have the job of managing the level of inflation in the national economy – they attempt to prevent high inflation and high deflation levels to help maintain a stable and productive economy. The majority of countries’ central banks will aim to maintain an inflation rate of between 2% and 3% a year.
- What are the effects of inflation? How does inflation affect us?
Inflation and price rises can also be thought of as a deterioration of the spending power of your money. For example, if a can of Coke costs a dollar and if the annual inflation rate is 4% then in a year the price of the same can of Coke will be $1.04. This means your money is going less far in all areas of spending.
- Why is inflation important indicator?
Because of these factors, inflation is an important part of the economy’s ability to function and grow. Economic progress and development can occur with deflation. Normally, inflation happens if there is an excess of money in the economic system – this drives prices up.
It is important to keep inflation in mind when managing your household income, wealth and assets. If the rate of growth on these things is at or above inflation, then your financial status is at least being maintained. However, if the rate of growth on your income, wealth and assets is below inflation, your financial value is being eroded over time.
A common example of when the value is eroded is to do with wages. In some nations, minimum wages will rise, but at a rate below inflation – this means the average income can purchase fewer goods than before. Prices are rising at a faster rate than income levels, and people are worse off.
This is why it is important to understand what inflation is, and how to protect yourself and your investments from inflationary pressures. The goal is to maintain the purchasing power of your money and the value of your portfolio of investments. By applying the following three methods, you can help protect against inflation.
- 3 ways to protect yourself against inflation
Method 1 – Investing in the stock market
Investing in stocks can be an effective tool against inflation. Although many people think investing in the stock market is complicated and risky owning equities can help protect the value of your portfolio.
The main idea behind investing in the stock market is that the value of your stock will be pulled upward with the price increases of inflation. As prices rise, businesses will be able to sell services and goods at higher prices. This will lead to higher revenues and profits for the company and a higher share price for you as an investor in that company’s stock. To benefit from this movement you can pick stocks from industries and sectors that perform especially well during inflationary periods.
A popular and effective example is commodities and commodity stocks – including companies involved in oil, grains and metals extraction and supply. These companies have stronger pricing power during periods of inflation – meaning that the prices of these goods items will more likely rise in periods of inflation as compared to other sectors.
However, this is not always simple as sometimes businesses will face increasing costs from the price rises in the economy. Revenues may rise, but if costs also rise at the same rate, there will no benefit to bottom line profits for these companies and no benefit to your investment.
The best option is to find stocks that will experience gains but also have histories of strong profitability – healthcare is a good example. Also keep an eye out for dividends when looking to protect against inflation – they can help add value to your portfolio of investments when returns in other areas are being eroded.
Method 2 – Property
Buying a home is a good idea to protect against inflation. Investing in the real estate market can reap the rewards if carried out correctly and with the required research. The primary goal when protecting against inflation is buying a home rather than dabbling in the property market.
Focusing on home ownership is a stable source of value compared to investing in property for a short term opportunity and should be viewed as a long-term investment – for at least 2 or 3 years. This allows enough time for the value of the house to increase. As you pay off your mortgage, you own a larger and larger share of the home until you own the entire place – usually over the course of 20-30 years.
Then, you have a debt-free asset in your portfolio which will continue to rise in value over time. Home prices, similarly to land values, rise annually, typically in line with inflation. Although there are bubbles and slumps in the market as a long-term holding, you will see gains in value. The value of homes has grown in line or above inflation historically over the long term, and this investment will be protected from inflationary pressures. This is a better choice than just keeping money in the bank in a savings account – which by the time you retire will not have grown in value as fast and may even have lost value.
Method 3 – Self Investment
One of the best ways to protect against inflation and other uncertainties in our future is to invest in ourselves. This means to work on putting yourself in a position to increase your present and future earnings potential.
For example, education is a great choice. New skills can add value to you and help you achieve a promotion or expand your business. Education also works for recession protection. In an economic downturn, you will be in a better position to protect your income stream. This can be the most controllable method of protecting against inflation. With investments, you are never 100 percent aware of in control of the performance and factors involved. However, with yourself, you can control how much effort you put into your endeavours and subsequently the rewards to be gained. It is an easy and immediate boost to your potential. Boost your future earnings by investing in yourself and help protect against inflation.
Inflationary pressures can be managed as long as you identify the risks you may be facing. Ignoring this issue will only hurt your value and investments in the long term, and it is important that this risk is addressed head on.
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