Inflation, one of the most important economic indicators, can affect your investments in a number of ways. Inflation is a general increase in the price level of goods and services over time. When inflation increases, it means that your money will be worth less than it used to be because its purchasing power will fall as prices go up. As a result, investors are often looking for ways to protect their assets against inflation and a decrease in purchasing power.
One such way to protect their assets often includes alternative investments. These kinds of investments could offer you more stability than traditional stocks, however, it is important to understand each asset class, and how a changing environment can affect them.
What is Inflation?
Inflation is a general increase in prices of goods and services. Inflation can have many causes, including changes in monetary policy, increased government spending and printing of money, as was the case during the pandemic.
A change in inflation can have an impact on your investments because inflation erodes the purchasing power of your income or savings (in other words: if you earn $100 today and there's 4% inflation over the course of a year then you'll only be able to buy $96 worth).
The Impact of Inflation on Alternative Investments
Inflation can impact returns and make it difficult for investors to achieve their investment goals. It is important to consider inflation in your investment strategy so that you can manage the impact on your portfolio or retirement income.
Inflation can impact the value of your real estate investment by increasing interest rates, which makes it more expensive for buyers to borrow money for mortgages. As a result, home prices are likely to fall if there is an increase in inflationary pressures.
Alternative investments have the potential to perform exceptionally well during inflationary periods as many times alternative assets are things that continue to be consumed regardless of prices, such as oil, crops, shipping, and infrastructure.
What Assets do Investors Consider In Inflationary Times?
Certain commodities have historically performed well during inflationary periods, such as gold, oil, and crops. During inflationary periods, these commodities tend to go up in price, as do the finished goods that are made with them. Raw materials that are used to create consumer staples tend to do well, as the increased costs are passed on to consumers.
Real estate has historically done well, however, should always be approached cautiously, as we have been in a decade of historically low interest rates. Low rates can create outsized demand for homes, and increases in interest rates can put downward pressure on prices, as people are able to borrow less than they were before the increase in rates.
The Case for Real Assets
When you're thinking about inflation and the future of your portfolio, it's important to understand that real assets are a hedge against inflation. They have low correlation with stocks and bonds so they can provide diversification for your portfolio.
Inflation is a threat to returns on your investments. You want them to grow over time, but if prices go up faster than what you earn on that investment, then your purchasing power decreases. Real assets—things like gold and oil—have historically been some of the best hedges against inflation because they don’t tend to be correlated with financial markets or stock prices during periods where there is high inflation (i.e., periods when money loses value).
When considering real assets, sometimes it’s helpful to go back to the basics, and think about the things that make daily life possible. Folks will always need access to utilities, internet, gas, and water. Regardless of how expensive these things become during inflationary times, the costs will be passed down to consumers, and will still be utilized.
Transportation is another sector to consider when looking at hard assets, as no matter what, we still have to transport materials and people around the globe on a daily basis.
Why Have an Alternative Investment Strategy?
As we discussed above, inflation is a real risk to the long-term value of your investment portfolio. With alternative investments, you can hedge against inflation and put yourself in a better position to provide for your future self.
In addition to protecting your wealth from inflation, these alternative investments can also help you achieve higher returns than traditional investments like stocks and bonds.
The bottom line is that inflation is a reality, it’s not going away and we have to live with it. There are many strategies that will help your portfolio fight its effects, and everyone will have a different approach, but the one thing we all have in common is that we need to plan and execute on a strategy that will put us in the best possible position for success.