How to Protect Your Wealth From Inflation
The COVID-19 pandemic shook markets a year ago, due in no small part to the global economic shutdown and fears about its long-term financial ramifications. Interest rates, which were only beginning to climb back out of the basement prior to 2020, were once again slashed to near-zero in order to bolster the economy while the world grappled with an unprecedented public health emergency.
These and other efforts to keep lending and borrowing moving, in spite of significant economic uncertainty, have had some effect. The markets have rebounded (and even rallied) during the darkest days of the pandemic. The strategies employed by the Federal Reserve during the Great Recession have, once again, served to soften the economic blow to the markets. At the same time, however, they’ve also opened the door for inflation to come roaring back.
Inflation can be a dirty word for most investors. When the purchasing power of the dollar falls, investments lose their potency. Plus, consumer confidence and spending tends to dip as well, as the average person reevaluates whether or not that suddenly-more-expensive splurge purchase is affordable after all.
These and other inflation-related obstacles can create headwinds for growing the value of your investments. That said, it’s still possible to protect your wealth from inflation, so long as you know where to look. Some investments can even help you take advantage of inflation as well. Here’s what you need to know about protecting your wealth from inflation and, with the right strategy, even benefit from it.
How inflation can harm your investments
When inflation strikes, the cost of goods goes up and the purchasing power of the dollar drops. But the impact of inflation goes beyond the rising cost of a gallon of milk: for investors, inflation can rob your assets of their real value. A $70 share may increase to $80 over a 10-year span, but if inflation also rose throughout the decade, that $80 may only get you the equivalent of $70 worth of purchasing power today.
Here’s another example: the Consumer Price Index in January 2020 was 2.3, which reflects a 2.1 increase in the general price of consumer goods versus 12 months prior. A $1,000 smartphone in 2019 would cost $1,460 in 2020 dollars. If your income stayed flat between 2019 and 2020, you’d get the same device for more money—your purchasing power decreased, and so too did the real value of your money.
This logic holds up for investments as well. If inflation causes the price of goods to rise and the purchasing power of a dollar to drop, the interest you earn on your investment may not be worth as much as it would be if inflation were flat. Inflation is particularly damning for bonds: a bond that pays out 6 percent interest in five years’ time may actually leave you with less money than you started with, at least in terms of purchasing power, if the CPI expanded by 6 points in five years’ time.
What conventional investments hedge against inflation?
Bonds are a go-to for many investors seeking diversification and a hedge against turbulent markets. But, as we’ve mentioned earlier, your average bond might actually set investors back when inflation is on the rise. That means getting more creative with your options—especially if you want to come out ahead with your hedge against inflation.
There are some options within the world of conventional investing that can offer protection against inflation. Some securities—and even bonds—factor in the investing challenges brought on by inflation. Other options, particularly within the ETF sector, can help investors capture some value from sectors that shine when inflation grows.
Thankfully there are several options available to inflation-wary investors. The first and perhaps most common is, paradoxically enough, Treasury bonds. Treasury Inflation-Protected Securities are a subsection of the bond market that adjusts its principal to account for CPI changes. When inflation grows, TIPS’ principal rate increases to make up the difference. The inverse is true for deflation: when the CPI drops, so too does the TIPS principal amount.
The interest paid on your principal therefore varies depending on changes to the CPI over a six-month period. This is also true for when your bond matures: TIPS pay out the adjusted principal or the original principal depending on which value is greater. This option can provide the creature comforts of bonds while also incorporating a hedge against inflation.
TIPS Exchange-traded funds
There are a host of ETFs that are designed to hedge against the impact of inflation in your portfolio, primarily by tracking their investments to TIPS bonds explained above. Instead of buying bonds directly, these ETFs allow investors to purchase shares of funds that include underlying TIPS holdings. This provides additional flexibility for investors who may not want to buy into TIPS directly, or who want to take advantage of the differing end dates of TIPS funds—which can come with their own investing benefits.
The nature of TIPS bonds is such that a newer bond may benefit from increased inflation rates more than an older one, especially if they are both exposed to deflation during the duration of the bond. With a TIPS tracking ETF, you can take the timing and hassle out of direct TIPS ownership and instead invest with a fund that manages a portfolio of bonds with different term lengths.
What alternative investments hedge against inflation?
When inflation is in order, most liquid investments stand to lose value. That means there are only so many conventional investment opportunities available if you’re looking to protect your portfolio from inflation’s consequences. Rather, periods of increasing (or high) inflation benefit real assets—be they precious metals, real estate, commodities, or other tangible assets.
The world of alternatives is much more vast than what the stock market can offer, be it with regard to investing to protect wealth from inflation or as part of a well-diversified portfolio. There are a host of inflation-busting alternative investments out there; some of which can even increase in value as a result of CPI increases.
Gold and other precious metals
Gold is perhaps one of the best-known alternative assets for hedging against inflation. Many investors seek shelter with gold investments when markets or shaky or inflation is on the rise. That’s because gold has a historic tendency to retain (or increase) in value during these economic conditions.
Investing in gold can take several forms:
- Gold bullion: purchasing physical bars or coins made of gold or coins. Buying physical gold can give you the peace of mind that comes with having a tangible asset, but gold bullion is often purchased at a premium and sold at a lesser price.
- Gold shares: a much more common option, as it doesn’t require the investor to hold onto physical gold bullion. This option also allows you to buy fractional shares of gold, rather than locking you than by the ounce. This gives you more financial flexibility.
- Gold exchange-traded products: if you’re not ready to buy-in on gold directly, you could buy shares of an exchange-traded gold fund. These funds include ETFs, closed-end funds, and exchange-traded notes. With this option, you can avail yourself to gold’s underlying performance without having to buy in gold as bullion or shares.
Gold is typically able to protect wealth from inflation because it’s a tangible asset. Even when you buy shares or gold exchange-traded products, you’re still investing in an underlying asset that’s physical. Plus, the limited supply of gold around the world, and its practical application in electronic devices, makes it a resource that’s always in demand.
Bear in mind that gold can be an expensive option for hedging against inflation. Given its popularity, particularly after the 2008 financial crisis, gold prices have remained steady. Gold will give you protection from inflation, but may not be the best option for value-driven investors.
There are other assets with inflation-protection that don’t require the same compromise on returns.
Real estate investing
Real estate investing can be another option to consider when seeking shelter for your wealth from rising inflation. Much like gold, real estate’s main advantage against inflation is being a tangible asset. Whether that means owning a house, a condo, commercial property, or farmland (more on that later), your investment in an actual structure or plot of land is further removed from the whims of the market and the purchasing power of the dollar.
When you invest in real estate, you avail yourself to long-term appreciation that can potentially offer a return that isn’t predicated on the factors that drag down stocks and equities when the CPI increases. This is because you’ve converted your liquid assets into something tangible: the price you paid for the property is locked in and doesn’t change based on the strength or weakness of the dollar. Instead, you have to consider whether or not the property purchased will appreciate by the time you decide to sell.
If you’re not ready to commit to buying land or property, you can also look into how a real estate investment trust (REIT) would fit into your inflation-proofing plans. With a REIT, you can buy shares in a property rather than buying it outright. REITs give you the ability to move your money into real estate in smaller increments if you choose to. You also won’t have to deal with the challenges that come with leasing and maintaining your own property, as the REIT takes care of these details.
Residential and commercial real estate does come with its drawbacks, however. Although you may not have direct exposure to inflation like you would with liquid assets, you still run the risk that these economic conditions make it hard to find renters. After all, if consumers find that their dollar doesn’t go as far as it used to, you might have to lower your rent to find occupants. If inflation turns into “stagflation”—when high unemployment, stagnant wages, and inflation all coincide—you may also find it hard to sell a home when the time comes.
Thankfully, these aren’t the only real estate options around. In fact, farmland investing can provide you with many of the benefits of commodities, real estate, and REIT investments all under one umbrella.
Farmland investing provides investors with an opportunity to protect their wealth from inflation, while also diversifying their portfolio.
Food is the third-largest category used to calculate the CPI. It’s a necessity for all households and comprises about 10% of the Americans household budget. This means that inflation is partially calculated based on the price of key commodities, of which agricultural products are a core player.
With farmland investing, investors typically earn returns from land appreciation when you sell, and, depending on the management structure, annual cash income from the sale of the crops. Because farmland returns are inherently tied to food prices, they tend to benefit from rising inflation. In fact, farmland has a 70 percent correlation with the CPI, and a nearly 80 percent correlation with the Producer Price Index, which tracks the change in sale prices.
This means that instead of having inflation drag down your portfolio’s value, your farmland investments should maintain, or in some cases, appreciate in value.
Those aren’t the only advantages to farmland investing, however. In fact, there are several other elements to farmland investing that other inflation hedges don’t. Farmland investing also helps your portfolio by unlocking access to a historically stable real estate class. The average acre of farmland has increased consistently for more than 15 years, and demand for agricultural goods is set to rise throughout the next 20 years.
Moreover, not only can farmland produce annual cash crops, but farmland also creates reliable appreciation to augment investors’ returns over time. That, too, is connected to inflation where the limited supply of arable land combined with what it produces maintains its value.
Even with record-high inflation in the 1970s, farmland kept pace. The likelihood of a slow-growth financial period ahead of us means that the same attributes that helped farmland stay stable during this era can help make it an alluring, inflation-busting investment in the present.
Why farmland is an optimal choice to protect your wealth from inflation
When looking for the best hedges against inflation—or any kind of portfolio diversifying asset—the key is to pick an investment that offers several opportunities at once. Farmland investing provides the steady and stable performance of gold, the ease of REIT investing, and the benefits of being closely tied to commodities. Better still, you can even make passive income through farmland investing when a farm’s crops go to market.
It’s never been easier to get started with farmland investing. FarmTogether takes out the guesswork of picking a farm, doing due diligence, and then having to participate in active property management. Instead, our investments are selected and researched by a team of seasoned farmland investing professionals. We provide our investors with a wide assortment of investment opportunities that take as little as $10,000 to start with. This is much more manageable for most portfolios versus outright ownership of farmland, which can be out-of-reach for investors.
FarmTogether makes getting started simple. Our intuitive investing platform makes it easy to track performance, scout for new opportunities, and look at the research that goes into picking out the best farmland investment options. All you need to do is create an account in order to be paired with one of our team members who can help you assess your options and the best match for your portfolio.
Protecting wealth and market gains from inflation can be a daunting task. The biggest opportunities sit outside the conventional investing market, meaning you’ll need to explore alternatives if you want to maximize your hedge. As far as inflation-resistant alternative investments are concerned, it’s hard to beat farmland.
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Disclaimer: FarmTogether is not a registered broker-dealer, investment adviser or investment manager. FarmTogether does not provide tax, legal or investment advice. This material has been prepared for informational and educational purposes only. You should consult your own tax, legal and investment advisors before engaging in any transaction.