Death, taxes, and inflation are three things in our lives that we cannot escape. The U.S. has gone through many brief periods of deflation, but for the most part, economic progress is accompanied by inflation. Often forgotten, inflation’s out-of-sight, out-of-mind force is being felt heavily today to a point we can’t ignore. The price of gas has increased year over year by 40%, and since the start of the pandemic, food prices have jumped almost 12%. It is affecting how we live our lives in an unprecedented way. Previous generations have had to battle inflation, but unfortunately, it is becoming more and more difficult as the price of goods has wildly outpaced the average salary increases in recent years. In last year’s annual shareholder meeting, Warren Buffet commented, “We are seeing very substantial inflation. We are raising prices. People are raising prices to us, and it is being accepted.”
It’s clear that inflation is here to stay. The only question that remains is what do we do with it? Here are some timeless tips to be able to better battle inflation and protect yourself from rising costs.
What Is Inflation?
Let’s start with the basics. Inflation is the general increase in prices and decrease in purchasing power of money. Things cost more; therefore, your money doesn’t purchase what it used to be able to. Time for a quick example. Let’s say the inflation rate is 10%, the $1.00 candy bar would cost $1.10 a year from now. Since the candy bar requires more money to purchase, it effectively makes your money less valuable. This may seem trivial when it comes to a candy bar, but when you think about all goods in the market being inflated, it becomes much more impactful. For example, if the inflation rate is 5% and you received a 3% raise from your company, you actually just received a 2% decrease in salary. You can quickly see why learning how to battle inflation is crucial in our pursuit of financial freedom.
The most common inflation indexes are the Consumer Price Index (CPI) and the Producer Price Index (PPI). Both the CPI and PPI measures change in prices over time for a given set of goods and services to provide an accurate picture of inflation in the economy.
Key Ideas:
- Inflation decreases the value of money, making things more expensive.
- The Consumer Price Index (CPI) and Producer Price Index (PPI) are designed to measure and report on inflation in goods and services over time.
- At its best, inflation can stimulate the economy and produce economic benefits such as boosting consumer demand which drives economic growth.
- Inflation affects everything from the cost of living, mortgages, borrowing rates, cost of doing business, and everything else in between.
Practical Steps To Battle Inflation:
When prices are rising, it is important to have tools in the tool belt to battle inflation effectively. We will cover four practical tips to apply to shield yourself from the effects of inflation.
1) Invest In Great “Defensive” Companies
The stock market as a whole typically does not like inflation. Inflation makes materials and labor cost more which ultimately hurts the earnings of the company. It is seemingly counterintuitive that investing through inflation would be a good idea. However, it is a great place to park your money during inflation, especially when you have a well-balanced portfolio with “defensive” sectors in it.
Defensive sectors are industries that tend to stay stable whether the market is doing well or not. Think consumer industrials, health care, energy, utilities, etc.. These industries have the ability to raise their prices and are essential in our day-to-day lives. The defensive sector has proven to do very well during periods of heightened inflation and has a place in most diversified portfolios.
2) Invest In Tangible Assets (Real Estate & Precious Metals)
Precious metals, namely gold, have long been the safe haven during periods of high inflation and economic instability. Precious metals sometimes move opposite to the U.S. dollar because they are denominated in U.S. dollars, which makes them a great hedge against inflation. In practical terms, if inflation goes up making the dollar less valuable, then gold goes up making gold more valuable. Example: If gold is worth $100 today with an expected inflation rate of 10%, then a year from now the gold we own would be worth $110 effectively negating the impact of inflation.
Similar to precious metals such as gold and silver, real estate tends to hold its value well during inflation. As prices rise, so will the property values and any associated rents with those properties. This increases the amount of rental income earned along with the overall value of the property.
Both investment classes make a great addition to your long-term portfolio, especially during periods when the economy is battling inflation.
3) Invest In Yourself
An investment in knowledge pays the best interest.
Benjamin Franklin
We clearly want to battle inflation and increase our purchasing power over time. An extremely effective way to accomplish this is by developing and investing in your talent. The great thing about investing in yourself is you are inflation-proof. You are effectively getting to purchase your education today for one rate but then can charge customers for the future rate without re-educating or reinvesting in yourself.
There are several ways to invest in yourself, from learning new skills online, going to school, or developing a side hustle that could turn into an entire business one day. Whatever you do today will have a compounding effect on your future. If only one thing in your life could compound, your skills and education can’t be too bad of a place to place your bets.
4) Practice Financial Discipline
Practicing financial discipline may be the easiest to explain on this list but the hardest to apply. It is so easy to fall into the habit of spending more than we make. When we do this, we are setting ourselves up for failure. Financial discipline is always good to practice, especially during high inflation.
“One of the great defenses to being worried about inflation is not having a lot of silly needs in your life.”
Charlie Munger 2004 Berkshire Annual Meeting
I think it is not a surprise that one of the most successful investors of all time doesn’t blame or look outside for answers but constantly searches for what he can do to best respond to the situation. The sad truth about inflation is we can’t control inflation. We can only control how we respond to it. We will be rewarded regardless of market conditions when we have practiced financial discipline.
