Inflation refers to the gradual increase in the prices of goods and services throughout the economy. It is measured by calculating the percentage change in a price index over a certain span of time, ideally over the previous 12 months. As Kavan Choksi says, while inflation is a natural occurrence in an economy, techniques for inflation hedging might be used to offset the expected drop in the price of a currency, so as to protect the decreased purchasing power. Inflation hedging may even assist in protecting the value of an investment.
Kavan Choksi sheds light on a few ways to hedge against inflation
If a person has money stashed in a typical savings or checking account, inflation may erode the value of their cash over time. Hence, it is better to move that money to a high-yield savings account. Having funds in a high-yielding savings account would help maximize money at a time when prices of various goods and services remain elevated. People already having a high-yield savings account should consider investing in the stock market and building a diversified portfolio. It would also be prudent to consider certain alternative investments, like commodities, precious metals and real estate, to hedge against inflation. Investors anxious about the decreasing value of a dollar may decide to invest in gold or precious metals. The price of precious metals like gold is generally independent of other asset classes.
Many investors also opt to put their money into real estate in order to take advantage of the high housing demand and beat inflation. As an asset class, real estate has intrinsic value and can provide consistent income. There would always be a demand for houses, no matter the economic climate, which makes real estate a good inflation hedge. As inflation goes up, so does the value of properties, and hence, the amount landlords may charge for rent. As Kavan Choksi says, one may even choose to invest in real estate investment trusts (REITs), which are more liquid and can be bought and sold in the markets with ease. REITs are companies that own and operate portfolios of discerning residential, commercial and industrial properties. They provide income through leases and rents, and commonly pay higher yields than bonds.
To hedge against inflation, investors may even try to diversify internationally. Most American investors generally lean towards stocks and bonds in the United States. This practice, however, might prove to be costly over the long term, particularly during the times of inflation. Improving international exposure can be a good strategy to hedge against inflation. There are many major economies across the world that do not rise and fall in tandem with the market indices of the United States. These countries include South Korea, Australia and Italy. Opting to add stocks from such countries can help investors to hedge their portfolio against domestic economic cycles. Bonds from foreign issuers can additionally provide investors with exposure to fixed income that does not go down in price in case the inflation rate increases in the United States.
