Robert Steinadler, 9 months ago
Inflation is getting out of hand and is increasing. This is not only a problem in the US but also for European investors as their purchasing power is melting away throughout the year 2022. Politicians and central banks are promising to do something about it and decrease inflation by raising interest rates and quantitative tightening.
It remains to be seen if this alone can save people since it doesn’t really matter if you’re an active investor or just a bystander who is not investing his money in anything. Your wealth no matter how big or small it is will be constantly eaten by inflation if the overall situation doesn’t change.
Time to equip yourself with some knowledge about asset classes that have the potential to serve as an inflation hedge and protect your capital against it.
While inflation has currently a negative effect on the overall wealth of the population it is a natural occurrence in the market. Inflation can be measured by comparing price levels for goods and services over time. If the same 100 Euros that bought you two tires for your car last year can only buy you one tire the next year, then inflation has decreased your purchasing power. The opposite state of inflation is deflation, which means that the same amount of money can buy more goods and services.
It remains controversial which goods and services should be measured to determine the inflation rate. A flat-screen TV might be stable in price while food prices are skyrocketing. The problem is that you have to eat every day but statistically speaking you are not so much dependent on the opportunity to acquire a cheap TV.
The harmonized index of consumer prices or HICP is an index that you should pay attention to. It measures the inflation in the EU which reached 7,4 % in April 2022. This was just the average inflation. Depending on where you live the situation might be better or worse. For example, Estonia held the record with a 19,1 % inflation in April 2022 while France was a little bit better off with only 5,4% inflation at the same time.
Cryptocurrencies like Bitcoin have created more than one controversy over the last 10 years. Some experts believe that crypto is not an asset class, while others argue that it is and the list has to be extended. Another controversy that has been created is the fact that especially Bitcoin has been discussed as an inflation hedge but when inflation increased starting at the end of 2021 crypto peaked at an all-time high only to see new lows in 2022.
Still, cryptocurrencies can serve as an inflation hedge and have an incredible track record. In 2011 Bitcoin was trading at a few Cents and reached an all-time high of $67.000 only 11 years later. BTC is already one of the most successful assets in the 21st century and should this trend continue in the long run it might fulfill its purpose.
Another factor is networks that are based on proof of stake. This allows creating income in an environment that otherwise won’t allow earning any interest on savings.
Many experts believe that gold is a good hedge against inflation. A perception that is also driven by historic events like the record inflation in Germany after the first world war. People had to carry their money in wheelbarrows and it inflated so fast that many households opted to use bills for heating rather than spending.
Gold kept its value during those difficult times. It is worth mentioning that gold is not creating any yield. Still, gold is considered to be useful to hedge against inflation and diversify a portfolio.
Commodities are very important goods that often are raw materials that are needed for production. Oil, grain, gas, and even gold are considered to be commodities just to name a few examples. The price of commodities usually foreshadows inflation since a rise in the price of commodities means an increase in prices for goods that are produced from them.
This asset class is considered highly volatile and under the influence of geopolitical events that might turn the market upside down in an instant.
Stocks and bonds are two different assets but combined they can build strong protection for your portfolio. A conservative portfolio to protect yourself from inflation would be a so-called 60/40 portfolio. It consists of 60 % stocks and 40 % bonds. If you don’t think that you’ll be capable of picking stocks there are plenty of options to build a set and forget portfolio.
The upside of a 60/40 is that it is usually a good hedge in times of heavy inflation. The downside is that it gets easily outperformed over a longer period of time by a portfolio that mainly consists of stocks.
There are two options to protect capital by investing in real estate. The first one is to own real estate and rent it out in order to create cash flow. Prices for property usually go up during times of inflation which eventually allow the landlord to increase the rent. This helps a lot in hedging against inflation but also requires you to buy and maintain the property.
The second option to profit from real estate during times of inflation is so-called real estate investment trusts. A REIT is a company that owns and operates real estate that produces income. By investing in a REIT you can earn dividends.
There is a wide variety of ETFs available and those that are based on an index are attractive to retail investors. The reason is simple, fonds usually have a hard time outperforming an index in the long run. Let’s say you would like to invest in tech stocks. An index like the S&P 500 won’t provide exposure to small companies but it consists of 35 % of the biggest tech stocks in the US.
It is hard to predict which ETF will provide better protection against inflation. One strategy is to use an ETF as an instrument to invest in a certain asset class like commodities for example.
The options that we have considered in this article are very basic and in some cases like real estate quite conservative. Others are more progressive and come with a different risk profile. In any case, we cannot and will not provide you with financial advice since it is impossible for us to assess your individual situation.
Aside from consulting a professional to discuss your personal investment strategy, there is also the option to do more research on your own. Please feel free to read through our other educational articles in which we are outlining basic knowledge about cryptocurrencies and blockchain technology as well as more detailed reviews of coins and tokens.
The best defense against inflation is the knowledge to assess one’s own situation, knowing the options at hand, and making reasonable decisions on your own. Make up your mind!
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