How to protect against inflation?
The impact of inflation on wealth and purchasing power is devastating. If the inflation rates are very high, you notice this immediately in your wallet. But even with only moderate inflation rates, there is the same risk for one's own prosperity, which, however, creeps in over time and is often not felt immediately.
You have to protect yourself against inflation, but is it possible at all? And if so, what is the best way to protect?
You have to protect yourself against inflation, but is it possible at all? And if so, what is the best way to protect?
Protect with this! ... especially real assets and foreign currency
- Equities
- Real Estate
- Jewelry, Precious Metals like Gold
- Commodities
- Short term accounts with interest rates close to the inflation rate
- Foreign non-inflationary currencies
Avoid this! … especially nominal assets in own currency
- Bonds
- Mixed mutual funds with a low share in real assets
- Cash at home
- Accounts with fixed interest rates which are far below the inflation rate
What happens during Inflation?
Inflation means that a dollar today will be worth less in the future. This characteristic is not an unusual one for a currency and is even desirable for a well-functioning economy. An inflation rate of around 2% is seen as the preferred target by various central banks and their monetary policy is geared towards this target. If the inflation rate is higher, sooner or later a central bank will start raising interest rates in order to push inflation back down. If inflation is too low, a central bank will lower interest rates to speed up the circulation of money again.
This direct influence of inflation rates on monetary policy has far-reaching consequences for every citizen.
Citizens are directly affected by the devaluation of money and their purchasing power based on their fixed income. Consumption is becoming more expensive, belts have to tighten. Citizens are also affected by the devaluation of saved assets as long as they are invested in assets yielding less than the inflation rates. Those who hoard cash will be hit the hardest because it doesn't earn any interest at all.
But citizens are also indirectly affected. Higher interest rates hurt not only the citizens, but also the companies. They now have to pay higher interest on their debts, so that they are negatively influenced in their business model. At the same time, companies are missing a part of the consumption due to the increased saving behavior of consumers. This can be offset by higher prices, but overall corporate profits tend to suffer in times of rising inflation. As a result, there are more layoffs and higher unemployment.
This direct influence of inflation rates on monetary policy has far-reaching consequences for every citizen.
Citizens are directly affected by the devaluation of money and their purchasing power based on their fixed income. Consumption is becoming more expensive, belts have to tighten. Citizens are also affected by the devaluation of saved assets as long as they are invested in assets yielding less than the inflation rates. Those who hoard cash will be hit the hardest because it doesn't earn any interest at all.
But citizens are also indirectly affected. Higher interest rates hurt not only the citizens, but also the companies. They now have to pay higher interest on their debts, so that they are negatively influenced in their business model. At the same time, companies are missing a part of the consumption due to the increased saving behavior of consumers. This can be offset by higher prices, but overall corporate profits tend to suffer in times of rising inflation. As a result, there are more layoffs and higher unemployment.
Is it possible to protect against inflation?
Yes, it is possible to protect against inflation. However, this protection is not always immediately effective. The most important factor is a secure job and an employer who, in times of inflation, also raises wages consistently with inflation rates. It is therefore well advised to think about difficult economic times when choosing a job.
In strong business years, you should set aside as much of your income as possible. On the one hand for long-term wealth accumulation, on the other hand as an emergency fund to cover events such as job loss or longer phases of high inflation.
In strong business years, you should set aside as much of your income as possible. On the one hand for long-term wealth accumulation, on the other hand as an emergency fund to cover events such as job loss or longer phases of high inflation.
How to protect against inflation?
While an emergency fund must be available at short notice, low-fluctuation forms of investment such as current accounts or low-risk bonds are suitable for this. These capital investments in particular are less well suited to protecting against inflation in the long term. As a rule of thumb, long-term return expectations must be higher than inflation. A 2% interest rate with 8% inflation would effectively mean a 6% loss in wealth per year. To combine an inflation protection with short-term availability, the emergency fund can be deposited in a foreign non-inflationary currency.
Real assets are the best way to protect yourself from inflation in the long term. These include real estate, precious metals and jewelry, commodities and, above all, equities. From a long-term perspective in particular, equities, followed by real estate, have proven to be the most reliable forms of assets to protect against inflation. However, both also have a downside, because especially at the beginning of an inflationary period, both asset classes suffer as a result of rising interest rates.
For this reason, a distinction should be made between hedging against high inflation and hedging against rising inflation. Once inflation has stabilised, companies and property owners can adapt to the new situation. In times of rising inflation, effective hedging with equities and real estate is not possible. During these times, commodities and precious metals like gold can offer protection. Accounts in foreign currencies that are not subject to inflation are also very effective.
Real assets are the best way to protect yourself from inflation in the long term. These include real estate, precious metals and jewelry, commodities and, above all, equities. From a long-term perspective in particular, equities, followed by real estate, have proven to be the most reliable forms of assets to protect against inflation. However, both also have a downside, because especially at the beginning of an inflationary period, both asset classes suffer as a result of rising interest rates.
For this reason, a distinction should be made between hedging against high inflation and hedging against rising inflation. Once inflation has stabilised, companies and property owners can adapt to the new situation. In times of rising inflation, effective hedging with equities and real estate is not possible. During these times, commodities and precious metals like gold can offer protection. Accounts in foreign currencies that are not subject to inflation are also very effective.
The Do's and Dont's during periods of inflation
As inflation rises, precious metals like gold offer good protection. Equities and real estate are best suited to protect assets against long-term high inflation. Even more, equities and real estate have the ability to increase wealth beyond inflation.
All forms of investment that offer an interest rate below the inflation rate should be avoided. An exception to this is the emergecny fund, which can be required during these times. To protect them against inflation, these emergency funds can be deposited in foreign non-inflationary currencies.
Changing jobs in times of rising inflation should be avoided if a secure employment has been available beforehand. Once inflation has stabilized and the economy recovers, wage compensation to compensate for the loss of income caused by inflation should be claimed. If the employer is not willing to do this, it may be worth changing jobs if the opportunity exists. Because the reality of the new inflationary market condition will have had a corresponding effect on wages on the labor market which makes it likely to get a higher compensated when changing the job.
All forms of investment that offer an interest rate below the inflation rate should be avoided. An exception to this is the emergecny fund, which can be required during these times. To protect them against inflation, these emergency funds can be deposited in foreign non-inflationary currencies.
Changing jobs in times of rising inflation should be avoided if a secure employment has been available beforehand. Once inflation has stabilized and the economy recovers, wage compensation to compensate for the loss of income caused by inflation should be claimed. If the employer is not willing to do this, it may be worth changing jobs if the opportunity exists. Because the reality of the new inflationary market condition will have had a corresponding effect on wages on the labor market which makes it likely to get a higher compensated when changing the job.