Back in 1950, a gallon of gas cost you .25 cents, a Chevy Corvette cost about $3,000, one pound of coffee cost $0.79. Inflation has an extraordinary affect on the purchasing power of goods, yet it is an invisible force that slowly robs people’s wealth. The great investor Warren Buffett also cautions against inflation for investors as well. Here is a compilation of all the things Warren Buffett has written about inflation http://csinvesting.org/wp-content/uploads/2012/09/buffett-inflation-file.pdf
In 2008, the federal reserve effectively tripled the money supply with the TARP bailout of the banks and the proceeding quantitative easing. The basic principle of supply and demand ensures that the cost of living and the price of goods will go up in time because more money is chasing less goods. When the supply of money increases at a disproportionaly large rate, and there is nothing to back up this money with gold or silver, then inflation will soon hit because the value of each dollar will diminish. Because of the financial crisis in 2008 and a huge recession afterward, economies around the world contracted or slowed down, and the demand for goods and services decreased. Given that the supply of money in the US from the stimulus packages and bailouts, many are left to wonder why inflation has not increased more than the 1-2% a year after. For now, the velocity money has been kept at a lower rate because of the economic slow down, however, once the US economy picks up, and people start buying more houses, cars, goods, and services, then inflation will start to creep up. So after reading all this, how does one prevent losing their wealth do to higher inflation? How do you hedge against inflation?
There are several options, but these are one of the most popular.
Investing in Gold and Silver.
Gold and Silver are an excellent store of value as they have always kept their value, while every single fiat currency that has ever been in existance has gone down to 0 (which is their true value because nothing is really backing it up other than our trust in the government). There is an inverse relationship between gold and silver and the value of the currency. Triggers for gold to spike up are rampant inflation, lack of confidence in the economy, and political instability. Gold and silver are real, tangible assets that are a great hedge against inflation. I used to purchase gold (GLD) and silver (SLV) etfs back in 2009 and made a good profit off of them, but you can buy gold and silver bullion as well if you want to hold your investments.
Investing in Real Estate
Real estate is another great way to hedge against inflation. As the value of the dollar goes down, it requires more of them to purchase real estate. In addition, certain areas are more desirable than others so if you were to own a home for many years and were fortunate to pick an up in coming neighborhood, then when you sell, you can realize considerable profits above what you originally paid for it. I like investing in real estate because it is tangible and useful as it provides housing. You can also go to a bank and use leverage to invest. In addition, with a tenant paying mortgage, tax savings from depreciation, cash flow opportunities, and appreciation, real estate makes a great choice in combating inflation (and making more money). (Make sure you choose the right property, not all properties make financial sense).
REITS or Real Estate Investment Trusts can also give you exposure to real estate as they are companies that own and collect rent from commercial and residential properties.10 Bundled into real-estate mutual funds. REITs do a decent job of combating inflation.
Investing in Consumer Staple Dividend Paying Stocks
Investing in dividend stocks is really just half a hedge. In times of mild to moderate inflation, then these dividend paying stocks work great, as companies pass on the cost increases to the consumer. However, in times of rampant inflation (double digit or even triple digit increases), companies (and their stocks) lose out as prices become too expensive for the regular consumer to afford and so sales decrease and so do profits. Looking historically from 1926 through 2002, when inflation was above 6%, stocks fell. Stocks did poorly in 8 out of the 14 years inflation exceeded 6%.
So what does that mean?
If you believe that once the economy picks up, inflation will increase but not by that much (not exceeding 6%), then dividend paying stocks in consumer staples such as the ones found in the Money Tree Portfolio are a good investment.
TIPS or Treasury Inflation-Protected Securities, are government issued bonds that are tied to the US inflation index. This means they automatically go up or down based on the inflation numbers put out by the US government. There is very little default risk as the US government is backing these bonds, but be careful of the inflation numbers put out by the government as they may not be a true reflection of the true inflation of the economy.
If you are worried about inflation diminishing your purchasing power, then you can hedge against that and start investing in the investments mentioned above.