Inflation is bound to happen. You may be seeing and feeling the effects of it now as the supply chain bottleneck continues and price tags for products continue to rise.
With inflation, it’s expected for prices of goods, like the price of gold, and services to change, usually with a steady percentage increase. But certain events can cause an unwelcoming, rapid rate of inflation change in the short run. It’s not only taking place in the United States. People globally are affected by this volatility and financial crisis in all areas of the economy.
You can safeguard your investments by layering asset types into your portfolio that provide you with added purchasing power during inflation. Consider gold, for example. It’s a commodity that holds a long-term value that can easily be added to your investment portfolio.
This article gives you an understanding of inflation, how it is determined, and what you can do to hedge against it.
Understanding Inflation
Inflation is generally 2–3 % every year, acting as a normal component of our economic system. The value of money decreases each year unless cash is in the form of an investment earning interest to keep up in the race of inflation.
Why Does Inflation Occur?
There are numerous causes of inflation. It includes:
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Increased wages and cost of materials
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Greater demand than supply
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Increased money supply
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Devaluation and lower exchange rate
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Changes in monetary policies and regulations
The COVID-19 pandemic has led to high inflation as we see the results of a rapid economic recovery. Unemployment remains unsteady, and there is a major supply chain demand. Grocery store prices are becoming more noticeable, even the price of gas.
It’s interesting how people react to it. For example, because of higher costs and commodity prices, they may demand higher wages to keep up with inflation expectations. Once higher wages are approved and paid, they react because prices for average items increase at higher rates.
There’s a chain reaction, whereas production costs can’t increase without compensating through raising the sales price.
Inflation Rates: How They Are Determined
You’ve heard of an inflation rate. It’s a calculation represented in the form of a percentage to express the price index change year over year. It all boils down to supply and demand.
Inflation rates stem from the price indexes. There are three price indexes to watch for:
- Consumer Price Index (CPI)
- Producers Price Index (PPI)
- Personal Consumption Index (PCE or PCEPI)
Inflation impacts your investments, amongst all other things. Why? Because when inflation is high, the value of the dollar decreases.
Price indexes serve three functions:
- As an economic indicator
- As an economic deflator
- As a basis for contract adjustment. It’s primary purpose stands to flatten revenue streams in order to measure the true growth of output.
In the U.S., the most common price index is known as the consumer price index (CPI). It is also referred to as a cost-of-living index. The consumer price index measures the change of price levels of consumer goods and services. The Bureau of Labor Statistics is responsible for releasing the CPI.
In identifying the change of price levels, CPI focuses on products or services available for consumption by households within the U.S. Its purpose is to adjust income and expenses based on changes in cost of living.
Social security recipients are directly affected by CPI. The Social Security Administration (SSA) uses this index to calculate annual adjustments based on the changes in cost of living.
The Producers Price Index (PPI) like the CPI measures the price change of goods and services. It is also published by the Bureau of Labor Statistics.
PPI differs from CPI in the type of data collected and the targeted products or services. PPI captures all output of the U.S., including those purchased by producers and those purchased by consumers, whereas CPI looks at household consumption.
PPI is the driver to CPI. If a company needs to pay more for its cost of sales, price adjustments shortly follow.
Another measure of inflation is through the Personal Consumption Index. Here, the change in the price of goods and services across the economy is tracked and measured. Sounds the same as the Consumer Price Index, right? CPI and PCE are very similar. The Bureau of Economic Analysis releases the PCE, and that’s the main difference between the two, but that’s not the only difference.
The two indexes are not weighted the same. PCE looks at data and focuses on what businesses are selling. CPI is focused on what households are buying.
Also, the two indexes have a difference in scope of coverage. PCE is well-rounded, covering all out-of-pocket expenses in addition to those paid indirectly. For example, it includes costs covered by an employer for insurance policies. CPI excludes indirect expenses.
A third difference is their process in accounting changes. Each index uses a different formula when calculating the percentage change. PCE accounts for product or service substitutions whereas CPI does not.
What Is Inflation Hedge?
Inflation hedging relates to types of investment that protect you, the investor, from devaluing your portfolio due to the rising prices of goods and services in the long run. The best types of investments are those that maintain their value or increase in value over a longer period of time. Cryptocurrencies like bitcoin are more volatile and less reliable, while gold returns are more trustworthy.
There are a few types of asset classes you can use to battle inflation. This includes:
- Commodities, such as gold bullion and silver
- Real estate
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U.S. Treasury inflation-protected securities, such as TIPS
Looking back in time, gold served as a short-term inflation hedge during the 1970s and 1980s, where it had annualized returns of 28%. It’s also been proven as a long-term inflation hedge due to its higher than inflation return on investment. Its annualized return over a series of years has shown greater than that of the CPI Index rate compounded.
Combat Inflation With Gold
Combat inflation by investing in gold, amongst other commodities. Why gold? Gold is a rare commodity that carries an intrinsic value. It doesn’t rust, it can easily be melted down to a liquid and repurposed, and it maintains its value in every market.
Placing gold into your portfolio prepares you with a risk mitigation strategy in a long-run relationship. How? Gold has a good return on investment which strengthens your purchase power. It has an inverse relationship with the dollar. When the value of the dollar falls, gold prices soar. This is something to look out for in order to manage market expectations.
According to the World Gold Council (WGC), gold is listed as the second most liquid asset. Because of its popularity, it can be sold immediately on the market. It’s competition? The S&P 500 stocks. Gold is one of the most heavily traded assets on the market and remains in high demand. Have you looked at the recent spot prices and trends?
Let’s recap: what are the benefits of inflation hedging? Inflation hedging:
- Protects the value of your investments and equities during periods of inflation
- Keeps business operating and production costs low
There are options when investing in gold. It doesn’t mean you need to clear out a spot in your home and prepare for an invasion of gold bars or coins. You can if that is your preference and want to visibly see your fortune. Or, you can invest in other options which are not as obtrusive but still luxurious.
Here are some options to consider when adding gold to hedge against inflation:
- Look into gold subscription-based plans such as Acre Gold and build your investment over time.
- Purchase gold bars or gold coins outright from the market or with a financial advisor
- Include gold mining stocks in your portfolio
- Gold ETFs and Mutual Funds
- Gold Futures and Futures Contracts
As you can see, there are many alternatives to select from when purchasing gold. Choose the best avenue for your investment and win the war against inflation.
The Bottom Line
Inflation is a primary concern for investors, especially following the pandemic. Inflation is rushing in at a fast pace. But, you can prepare ahead of time and leave the worry behind by investing in gold. Keep the value of your investments balanced in your portfolio.
Include stocks, bonds, real estate, commodities, etc. Some play a game of risk, others act as a hedge against inflation. Whether one type goes up or down, historical data shows that commodities such as gold counteract inflation and currency debasement and yield high stock returns.
Gold is a durable investment that lasts a lifetime. Start investing in gold today the affordable way through a subscription plan you choose and control. Watch your gold grow over time with Acre Gold. Visit Acre Gold today and begin having gold bars delivered straight to your doorstep.
Sources:
How to Hedge Against Inflation: 5 Best Investments
Inflation: Definition, 6 Economic Causes
The Best Inflation Hedge You Already Own
Gold as a Strategic Inflation Hedge | Portfolio for the Future | CAIA