Managing Your Investments Against Inflation

If you’re keeping up with the financial news, you’re well aware that the media is somewhat overwrought about inflation. So should you be worried that your financial sky is falling? The short answer is no, but learning how the economics of inflation impact your investments will help you make solid long-term decisions for the future.

What does inflation mean in economics?

First, Economics 101. Inflation happens when the Consumer Price Index (CPI)—the organisation that measures the costs of goods and services—finds that goods and services cost more. You’ve probably noticed that basic commodities like gas and groceries are more expensive than they were a year ago. There are three reasons this happens:

• Demand exceeds supply
• Supply shortages
• Both scenarios happen simultaneously

Global economies, including Australia, are uncertain but slowly resetting after a year of Covid lockdowns. This is because so much of the economy stalled out last year—falling petrol prices had nothing to do with oil production and everything to do with lack of demand when you stayed home all the time—but prices are ticking up with renewed demand. In addition, the supply chain for many consumer goods had shut down, causing manufacturing delays until they get back up to speed. Adding to that, the government injected so much cash into the economy during the lockdown that there is an inevitable levelling out to happen while the labour force goes back to work and subsidies end.

Inflation can shrink your investments.

If you are retired or are nearing retirement, you would be keeping a close eye on the cash flow from your investments. But if everything from petrol to housing costs more, do you have the income to keep up with rising costs?

Some assets can withstand moderate inflation if they appreciate despite rising prices. If your income streams remain steady, then your assets are outperforming inflation. To be sure, ask your financial advisor for the “real” rate of return on your investments—the value of the asset relative to the rate of inflation. You may be surprised by your results. For example, if you have an investment that’s gone up in value by 3% annually when inflation is at 4% (based on July 2021 statistics), it is actually shrinking in real terms. This is a common scenario with retirees and those close to retirement who want safe and conservative investments. If this sounds familiar, it’s time to rebalance your portfolio.

If you are a traditional investor, keep in mind that bank deposits aren’t growing at a rate to meet inflation. So, ultimately, you could be losing money by paying the fees associated with maintaining deposit accounts.

How to use inflation to your advantage when investing

Since the economy encompasses every part of your life, does it make sense to invest in a broad range of industries? For decades, “investing” meant buying bonds for a guaranteed income stream, or buying Certificates of Deposit (CDs) from your bank. But current low interest rates have reduced the return on these term deposits making risk-averse investors turn to alternative options. Regardless, neither of these investment strategies will keep up with the rising costs of living.

The problem is that the income from bonds doesn’t keep up with inflation, so you are stuck making less money. Even worse, the value of those bonds can drop on the secondary market, so you can’t resell them.

To help protect your investments against inflation, your best option is to balance your portfolio so that you have assets performing in inflationary periods, along with assets that provide income in low inflation times. There are many investment options to consider, but here are a few pointers to get you started: 

1. Equities—individual stocks and mutual funds—perform well when inflation is low, but don’t do as well when inflation is rising. They are a good long-term hedge. Opt for companies that generate cash rather than glamorous start-ups that devour it—buying stable blue chips tends to have better results in the long run.
2. Commodities are another way to shore up your income against inflation. Commodities are the raw materials that companies convert to other things. Such as metals, livestock, coffee, and oil—so if you own these, your assets grow when prices rise.
3. Precious metals — it’s widely known that gold has been the standard hedge against inflation for centuries. However, the reality is that there is little correlation between equities and gold. For many mature investors, they gravitate to gold without any data to confirm that investment decision. Now might be the time to reevaluate.
4. Real Estate is a popular option right now, but not as a property owner. Property management funds that buy and manage residential and commercial properties generate passive income and offer a decent hedge against inflation. And in cities like Melbourne and Sydney, banks offer mortgage pools to investors, yielding a relatively high return on investment for first-registered properties.
5. Cryptocurrencies—younger investors consider them the new gold as an inflation hedge but know the rules before you jump into crypto. Even though it’s like the wild west of investing, the ATO taxes your crypto gains as they would any other investment.

With so many investment options to consider, finding the right instruments that perform well during inflationary periods can be tricky. Getting professional guidance from a financial advisor to determine the best strategies for investing can make all the difference in safeguarding your nest egg.

Super Network has the expertise and the investment options to tailor your portfolio for maximum returns, regardless of the broader economy. If you want to learn how to balance your portfolio, contact us for a free consultation.