ILLUMINATION
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ILLUMINATION

Take These 4 Steps to Survive and Profit in an Inflationary Environment

Cash is trash: Inflation is burning through your hard-earned money

Image by Mediamodifier from Pixabay

Like most things in life, the economy moves in cycles. When the economy is growing and credit is expanding, businesses and consumers feel optimistic and increase their spending, thus pushing prices for goods and services higher. The opposite happens when the economy is contracting, and everyone turns into a pessimist. It is often in times like these that when everything gets cheaper, it pays to have that extra cash in hand to take advantage of opportunities, such as buying your dream house at a bargain price. Hence, the old adage goes — ‘cash is king’.

In this article, I argue that this time is different. Instead, ‘cash is trash’ — a phrase famously coined by the billionaire investor and philanthropist Ray Dalio. Ray is often cited as favoring that investors should hold a globally diversified portfolio, including real assets to protect against inflation. I then proceed with outlining 4 steps that you can take to protect against and even benefit from inflation.

So, why is cash trash?

To put it simply, it’s when your bank pays you interest for parking your money, which is less than the rate of inflation. For example let’s say your bank pays you 2% interest, while at the same time the inflation rate is running at 9%. Thus, adjusting for inflation you end up with a negative return, a real return of -7%.

And, why is this time different?

Because, for at least four decades, we never had inflation running at nearly double-digit levels. In other words, during a ‘normal economic’ cycle, policy-makers adjust interest rates accordingly to either boost economic activity by lowering rates, or by raising them to put a lid on an overheating economy. Usually, they take any necessary action to ensure that interest rates are at least equal to or greater than the ‘desired’ (2%) inflation rate. This time around, policy-makers around the world, including the Federal Reserve (‘Fed’) have been unacceptably late to the party in raising interest rates. As a result, inflation has been skyrocketing, currently running at approximately 9% for the US, whereas the Fed’s policy rate is lagging behind at around 2.5%.

To make things even worse, there are signs that the economy may be slowing down and therefore the Fed may not be able to afford to hike much further to close in on the gap. On the positive side, there are signs that inflation may be reaching a peak at these elevated levels. If you are interested to look at a more detailed analysis on this you can read my article ‘5 Charts Show Inflation Might Have Peaked Already’.

What caused the latest inflation story and why is it bad?

For a more thorough analysis of what caused inflation to surge you can read one of my previous posts here.

So, here are 4 steps you can take to survive and profit in an inflationary environment.

Step #1: Diversify well and across several dimensions

Diversification is a fundamental principle that applies to most aspects of our lives, whether financially, professionally, or even socially. The inflation situation is no different. Therefore in deciding where to invest your hard-earned money you should consider several asset classes, such as stocks, bonds, and alternative assets such as real estate and commodities. Spreading your risk internationally via investing in foreign currencies and countries can also help protect against inflation. For a more detailed analysis on diversification, you can read one of my previous posts here.

Step #2: Invest in real assets

Real assets like gold and other precious metals can be a good hedge against inflation, as they have been historically used as both a means of currency and a store of value. Furthermore, they are also in demand due to the fact that they are used as inputs in the manufacturing of several products, including electronics and high-tech products in general.

Commodities are also a good option to consider when seeking inflation protection. For example, getting exposure to energy and agricultural products, either directly or indirectly via investing in funds, can be a good strategy during times of rising prices.

Other options may include getting into real estate or investing in collectibles such as coins, paintings, and other unique products which can gain value with time.

Step #3: Invest in high dividend stocks and high-yield bonds to offset inflation

Equities can be a natural hedge against inflation. Although inflation can be tricky for the stock and bond markets, over the long-term equities can offer some protection against inflation.

Hence, it may be a good strategy in picking companies with sound fundamentals and with a business model which can do well in an inflationary environment. This is often the case with companies that produce innovative products, and which can protect their margins via passing through costs to the end consumer. Receiving high dividends and coupons is also a good strategy for protecting against inflation. Good risk management and diversification are of course essential elements in this respect.

Step #4: Invest in yourself

You shouldn’t forget about yourself and your human capital. You should aim to sustain and expand your human capital, thus increasing your professional productivity and ultimately your net worth. Therefore you should consider investing in yourself via further education, training, or even investing in your own business. There are always opportunities if you look carefully which can help you grow and prosper even in an inflationary environment.

Key takeaways

You can think of inflation as an invisible force, reducing your buying power and ultimately your well-being and prosperity.

This time around inflation may be more of a concern compared to recent years and therefore a more focused approach is needed to hedge against it.

Keeping a diversified approach to investing, and including real assets in your portfolio can help you remain protected to a significant extent, and even profit from it. Last but not least, investing in yourself is more important than ever, as boosting your productivity and efficiency can help you keep up and even outpace the rate of inflation.

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Legal Disclaimer: All views are strictly personal and intended for education purposes only. Under no circumstances can information in this article be considered as advice, investment or otherwise, nor can it be considered as a solicitation to trade in any securities. You should consult your personal adviser for any financial matters. Although information has been utilized from sources which are deemed to be accurate, no liability can be accepted for any inaccuracies. The author cannot be held liable for any adverse impact due to any action or inaction by anyone as a result of consuming this information. All rights reserved.

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Spyros Ierides, CFA

Spyros Ierides, CFA

Sharing thoughts on financial markets, personal investing and self development.