Inflation Nation….rising prices and how it could end up robbing your wealth!!!
According to the Bureau of Labor Statistics, “over the last 12 months, the consumer price index for all items indexed increased 1.6 percent before seasonal adjustment.” (bls.gov). Albeit this number, alone, shouldn’t sound the economic alarm bell. Nevertheless, coming off our recent economic debacle—for which included the Federal Reserve Bank issuing well over $700 billion dollars to help bail out the troubled U.S. financial sector—many pundits now believe that the next phase in this millennia’s economic debauchery could, very well, be inflation—a struggling economy’s worst nightmare. Indeed, one such pundit appears to be economic forecaster Paul Ashworth of Capital Economics, a private forecasting group. “"We've seen this massive rise in agricultural prices that hasn't fed into consumer prices yet” says Mr. Ashworth. “As they do, the rate of inflation could rise to 2% by the middle of the year with higher food prices cutting into consumers' ability to buy other items.” (capitaleconomics.com). Still further, today’s gradual increase in overall prices, is tomorrow’s risk of lower personal wealth.
What’s inflation? Most economists would describe inflation as just an overall level increase in prices. Sounds simple enough right? But wait just a moment! When the overall level of prices increase, the negatives effects of it tends to lower the purchasing power of paper money, thereby adversely offsetting the many different investments money often buys. What causes this phenomenon is simply one of having a monetary system based completely off of fiat or paper money—namely, whenever there’s too much it in circulation, in order for the economy to adjust to these surplus dollars, prices tend to significantly creep upward. Nevertheless, in any inflationary environment, consumers seeking to preserve their purchasing power should discern these very important investment tidbits.
Still yet, here are a few investment tips to remember if prices start to climb:
IT MIGHT NOT BE A GOOD TIME TO SAVE…If prices were to start rising, oddly enough, one of the first things you don’t want to do is put all your money in a bank—to be precise, in an inflationary environment, savers are punished and debtors are rewarded. According to Stanford University's Hoover Institution and other sources, the average rate of inflation is about 3%. In other words, every year the U.S. dollar loses about 3% of its value. What this means in the realms of savings is that investors will have to be prudent enough to find savings plans at or above the level of inflation in order to realize any significant benefit.
Also, if the overall level of prices abruptly began to start rising, thus causing money to lose value, one thing that most economists advocate personal investors do is pay down any form of incurred personal debt. If you’re one of the millions of Americans struggling with credit card debt, high inflation could end up being your best friend—i.e., if you have exactly $10,000 of credit card debt and high inflation causes the dollar to lose 30% of its value, in theory, you only have to pay back 30% of the original amount. Theoretically, what you’ll be doing is paying back a debt with a weaker dollar, which can only benefit your overall personal financial situation.
STOCKS & BONDS…In essence, any financial market that involves the extension of credit—or monies—will be adversely affected by inflation. This said, stocks represent a fractional share of ownership in a corporation, thereby shielding itself from the perils of inflation. On the other hand, whenever you purchase a bond in a corporation, or from the government, you become a “bond holder” of debt instrument—to be exact, a bond holder is considered a creditor and would be, indeed, negatively affected by inflation. For example, as a bond holder, if you loaned monies to a corporation and was promised an annual return of 5 to 7 percent; if inflation increased at or above that level, then your personal wealth would be losing value from inflation at a pace much faster than it was generating income. In order to circumvent this phenomenon, the U.S. treasury issued a new Series of I U.S. Savings Bonds; which are 30-year bonds whose returns are adjusted for inflation. The earnings rate for Series I Savings Bonds is a combination of a fixed rate, which applies for the life of the bond, and the semiannual inflation rate—according the website treasurydirect.gov.
MUTUAL FUNDS & REITS…Most financial advisers will advocate that when long-term investments become a bit too risky, a potential safe haven to place monies into would be the short-term money market. Unlike bonds, interest rates on all mutual funds fluctuate and aren’t locked; therefore, it tends to adjust with the level of inflation. Also, if you think the U.S. dollar is going to weaken because of inflation, according to the website merckfunds.com, a good investment might be The Merk Asian Currency Fund (MEAFX) which typically invests in a basket of Asian currencies from countries like China, Japan, India, Indonesia, Malaysia, the Philippines, Singapore, South Korea, Taiwan and Thailand.
REITs an acronym for real estate investment trust, is considered by most to be a mutual fund for the investment in commercial real estate properties. The main reason why REITs could be a great inflation blocker is simply one of being tied to real estate. As a natural hedge against inflation, REITs are, indeed, a great investment option. “Commercial real estate—REITs’ primary asset—has been an effective inflation hedge for the last 30 years.” says Scott Crowne, a senior vice president and global portfolio manager for the investment firm Cohen and Steers. “Because it took such a beating over the past two years, real estate may be the cheapest real asset available. It is also an interesting way to invest in fully valued commodities at below-market prices.”
INVESTING IN A HOME…Truly, the only real safe haven for your personal wealth—and the ability to grow it—lies with investing in a home—to be exact, a home serves as an excellent investment vehicle to ride out any inflationary storm. On average, a home’s value should increase with inflation, thereby offsetting its ability to lower one’s personal wealth. “Although many experienced real estate investors are able to find hidden values in properties, most individuals should focus on purchasing a home with the intent of holding it, even if for only a couple years,” says Alan Brown, a real estate investment advisor. “Real estate investments usually do not come to fruition over several months or weeks, but normally involve an extensive waiting period in order for values to increase.” Investing in a home should make a lot of sense. In theory, whenever you borrow on a long-term mortgage (a major financial debt instrument used to purchase a home) inflation becomes a winning transaction—ones burden of debt depreciates while ones wages and income continue to rise.
INVESTING IN GOLD…If there were ever two investment fundamentals of preserving and creating wealth, then gold, very well, could be the ultimate investment for the individual investor. Further, whenever an economy is coming off the kind of economic ailments that it did between 2008-2009, savvy investors—seeking to preserve their purchasing power—should always look to investing in commodities (copper, aluminum, silver and gold). Historically, buying gold and silver has been an excellent way of preserving purchasing power over long periods of time (goldmoney.com.) The website goes on to say the following: “Gold and silver are the only globally recognized currencies that cannot be created out of thin air, which makes both of them great stores of value (preservers of purchasing power) in the long-term. Unlike fiat currencies that can easily be debased, gold and silver remain the ultimate forms of money.” Investing in commodities can act as a perfect hedge against inflation. This should make perfect sense—after all, it was fiat based entities (derivative, credit default swaps, subprime mortgages, etc) that got us into this financial mess in the first place.
There are a lot of Americans who now believe that because of the government's massive spending to avoid the 21st century’s version of economic depression will rekindle the kind of 1970s style stagflation (inflation with high unemployment) that could do a lot of damage to investor’s individual portfolios. But investors should take notice that there are different investment options available that can counter-act inflation—should prices begin to start rising.