INFLATION HEDGE-AS EXPLAINED BY-ER. AVINASH KULKARNI

Saturday Brain Storming Thought (246) 26/10/2024

INFLATION HEDGE

An Inflation Hedge is an investment that is considered to protect the decreased purchasing power of a currency that results from the loss of its value due to rising prices either micro-economically or due to inflation

It typically involves investing in an asset that is expected to maintain or increase its value over a specified period of time

Key Takeaways of Inflation Hedge

1) Inflation hedging can be used to offset the anticipated drop in a currency price

2) Limiting downside risk is a major commonality between institutional investors and currency hedging is a common practice

Various Options for Inflation Hedge

1) Invest in Treasury Bonds

2) Purchase Gold or Precious Metals

3) Fund a high-yield savings account

4) Invest in the stock market

5) Buy alternative investments

a) Real Estate

b) Commodities

c) CDs ie Certificate of deposits

d) Cryptocurrencies

Gold and Inflation Hedge

Gold ie the yellow metal typically only guards against very high inflation

Cash and Inflation Hedge

Cash is often overlooked as an inflation hedge

While cash isn’t a growth asset, it will usually keep up with inflation in nominal terms if inflation is accompanied by rising short-term interest rates

Silver and Inflation Hedge

Silver can act as a hedge against inflation

Oil and Inflation Hedge

Investing in oil is one of the best ways to insure against inflation and protect your finance

Classification of Inflation

1) Creeping Inflation

Mild inflation, a very slow rise in prices of goods and services

The price increased by 3% or less annually

2) Walking Inflation

The inflation rate falls between 3% to 10%

Such inflation can be harmful to the economy

3) Galloping Inflation

The rate of inflation will rise above 10%

The currency of the country will lose value in the global economy

4) Hyper Inflation

This happens when the inflation is completely out of control

No measures taken by the monetary authorities can control the prices

This is the last stage of inflation

Stagflation

Stagflation is a rare phenomenon where there is still an increase in the prices of commodities, but the economic growth has become stagnant

It causes economic instability due to the rise in unemployment, severe inflation, and lack of economic growth

Investing Strategy During Recession

1) During a recession, investors should avoid investing in companies that are highly leveraged, cyclical or speculative, as these companies pose the biggest risk of doing poorly during tough economic times

2) A better recession strategy is to invest in well-managed companies that have low debt, good cash flow and strong balance sheet

3) Countercyclical stocks do well in a recession and experience price appreciation despite the prevailing economic headwinds

4) Some industries are considered more recession-resistant than others, such as utilities, consumer staples and discount retailers

Real Estate Income and Inflation

Real Estate Income is the income earned from renting out a property

Real estate works well with inflation

As inflation rises, so do property values, and so does the amount a landlord can charge for rent

This results in the landlord earning a higher rental income over a time

This helps to keep pace with the rise in inflation

Hence real estate income is one of the best ways to hedge an investment portfolio against inflation

Impacts of Inflation

1) Increased cost of living

2) Higher prices for goods and services

3) Erodes purchasing power

4) Declining purchasing power causes cash to lose value

5) Puts pressure on discretionary spending

6) Stimulates production of goods

7) Lowers value of current obligations/receivables

Best Inflation Hedge

The most common asset classes for protection against inflation include gold, commodities, a balanced and diversified portfolio with a 60/40 split between stocks and fixed income, rental income from real estate, etc

Negative effects of Inflation

1) Uncertainty

2) Instability

3) Income Inequality

4) Eroding purchasing power

Positive effects of Inflation

1) Debt relief

2) Wage growth

3) Investment incentives

Benefits from inflation

1) The value of the borrower’s debt effectively decreases over time, making it easier to repay loans

2) Beneficial to government and businesses that have taken on substantial debt for things like building infrastructure or funding research