Simply speaking, inflation is defined as the rate by which the value of a currency declines and consequently the purchasing power also. Here a general level of prices of goods and services is seen to be rising and is a gradual process instead of a sudden process. It is a common phenomenon in any economy, be it developed or underdeveloped but there are ways to protect oneself from it.
10 rupees does not have the same purchasing power as it did five years back. Inflation is responsible for measuring the average price level of a specific basket of goods and services in the economy. Inflation can be determined depending on various factors but the most important is the current events and trends. Surcharge increase in raw material cost, higher wage level, scarcity of resources and more can be the reasons for inflation to occur.
Counterattack to inflation is called hedging. It describes a process of acquisition in sturdy assets, financially speaking, and can help one’s portfolio thrive even when inflation hits.
Ways to protect yourself against inflation are:
- Gold is the strongest hedging instrument available in the market. It is also looked upon as an alternative currency. The only weakness here is that when inflation occurs, Central banks will increase interest rates, and holding on to assets like gold will pay no yields.
- Commodities come second and line as hedging instruments which include precious metals, electricity, orange juice, natural gas, foreign currencies, other financial instruments. It is possible to invest in commodities through exchange-traded funds and the investor should be aware of the high volatility of commodities.
- Real estate investments are also inline. Rental income and property prices tend to rise when inflation occurs.
- Purchase of bank loans can be made by businesses that thrive during inflation. Purchase of senior secured bank loans provides higher yields to protect oneself from price drop if the rates start to rise.
- Investment in S&P 500 is also motivated because they include businesses that gained from inflation and require little capital. The current S&P 500 composition is of high technology businesses and these are capital-light businesses, making them a suitable avenue to rely on during inflation.
There have been speculations that Bitcoin may be a strong inflation hedge. They might even be so-called haven investments such as precious metals and real estate. The only shot coming here is a lack of investment history. Since its creation in 2009, it has not been a major factor in inflation hedging till now.
Experts even suggest that owning a piece of business, whichever be the sector, the strength of a currency might rise and fall but the product will remain in demand because of its consumption. A non-financial instrument that is good protection against inflation is upskilling and improvement of one’s existing technical skills.
Although it is expected that inflation will remain on a high even in the current year of 2022, it might not be a reason of concern. Investors can mitigate inflation risks by diversifying the portfolio’s inclusion of international equity ownership and focusing on cyclical sectors. It is also advised that this is the best time to address existing liabilities and borrowings to settle because of the favorable interest rates.