Inflation is an economic term used to describe a situation where the general price level of goods and services is rising. It’s measured by comparing the prices of goods and services over time, and it can be measured in terms of percentages or currency such as dollars, euros, yen, etc. Inflation lowers the purchasing power of money. For instance, an item that only cost one euro a number of years ago may now cost three euros. Thus, for any long term investor, a primary goal is to ensure their savings at a minimum beat inflation.
Many economists believe that a small amount of inflation is beneficial for long term economic growth. However, it can be difficult to feel this way as a consumer when your money isn’t stretching as far as it used to. Especially in times when inflation spikes into double-digits. Fortunately, there are steps you can take and investments you can make to protect yourself against the negative impact of inflation and even benefit from its effects.
1. Investing in low-capital businesses.
Low-capital businesses are businesses that have few up-front costs and require minimal operating expenses. This can mean a few different things, depending on the type of business.
For example, a low-capital business may be one that requires little more than some basic supplies and space to get started. Alternatively, it could be one in which one only needs to take out a small loan from a bank or other financial institution in order to fund the startup costs.
Low-capital businesses are protected against inflation due to their minimal running costs. They can raise their prices according to rates of inflation while keeping expenditures low. This means their profits – and your returns – are more secure.
Examples of low-capital businesses include:
- Consulting businesses
- Marketing businesses
- Information and technology businesses
- Other service-based businesses
2. Purchasing and Trading Bonds
Bonds are a type of investment that gives you the ability to earn interest. A bond is essentially an IOU that’s issued by a government or corporation. Unfortunately, in low interest rate environments, it can be difficult for a bond to beat inflation. In most cases investors are locked in to fixed rates of interest, and could find themselves on the losing end if inflation rises above their bond’s rate of interest.
When you buy a bond, you’re lending money to the issuer, who promises to pay back your principal at some point in the future, plus a certain amount of interest. There are several different kinds of bonds, and they all have their own unique characteristics.
Corporate Bonds: A corporate bond is a debt security issued by a corporation or other business entity. Corporate bonds typically have maturities ranging from less than a year to more than 10 years. Corporate bonds generally have higher yields than government bonds but lower yields than municipal bonds.
Municipal Bonds: A municipal bond is a debt security issued by a state or local government to raise funds for projects such as infrastructure development, schools, hospitals, housing, and roads. Municipal bonds are exempt from federal taxes but are subject to state and local taxes. Municipal bonds generally have lower yields than corporate bonds but higher yields than Treasury bills or notes.
Government Bonds: Government bonds are issued by the federal government to finance public projects such as building roads or funding social programs. Government bonds are considered very safe investments because they’re backed by the full faith and credit of the federal government.
Offshore Bonds: Offshore bonds are a type of investment that expatriates can make in their home country. This is an alternative to traditional investments like stocks and bonds, which may not be available to expats or won’t provide the same benefits. They can be used to diversify your portfolio, by having your money spread across different asset classes. Many expats choose offshore bonds because they allow you to avoid paying taxes on interest or capital gains on your investments, as long as you keep them outside of your home country.
TIP – Beat Inflation with Floating Rate Bonds:
Floating rate bonds offer a non-fixed interest rate, meaning the interest rate varies with market conditions. This allows for a guaranteed return on your investment, regardless of inflation rates.
You can buy these bonds through ETFs or mutual funds. EFTs and mutual funds tend to offer a wide assortment of such bonds. Thus, you’ll also get some diversification to help you protect your portfolio.
3. Investing in Stocks
Stocks can help you beat inflation by giving you the opportunity to invest in companies that are growing—and growing quickly. If you buy stocks in a company whose products or services are in demand, then you’re investing in something that’s likely to increase in value over time.
TIP – Choose Companies with Pricing Power:
Pricing power is a measure of how much a company can raise its prices and still sell more product. This is important because if the company can raise prices without losing customers, it has a strong position in the market and can make more money.
Some ways to identify companies with pricing power include:
- Looking for companies with a competitive edge. This could mean that they offer a product or service that’s unique, better than the competition, or one that’s simply cheaper. It also helps if they have access to an exclusive market or geographic area that other companies don’t.
- Finding companies with a growing market share. You want companies that are growing in their markets and taking over market share from others.
- Considering the company’s pricing competition. For instance, if a company is selling a commodity product—something like oil or rice—then they won’t have much pricing power because it’s easy for other companies to enter the market and offer similar products at similar prices. The more differentiated your product is from others on the market, the more likely it will be able to charge higher prices without losing customers.
4. Acquiring Hard Assets to Beat Inflation
Hard assets are things that have and tend to hold their intrinsic value, such as real estate, commodities, valuable artwork, etc. Acquiring hard assets can allow you to maintain purchasing power despite rising prices and depreciating currencies.
When you buy an asset, you’re essentially purchasing an item that will hold it’s value or possibly appreciate in value over time.
TIP – Investing in Real Estate: Although over the long term real estate is not the highest performing asset class, property values do tend to rise in line with or possibly beat inflation. This of course depends on the market, as real estate is very much location by location. While it would be foolish to put all of your eggs into one basket, most investors using proper diversification will hold some portion of their portfolio in real property.