The Best Financial Strategy During Inflation
Inflation is the ascent in the costs of products and enterprises over some undefined time frame. This means that with inflation, the purchasing power of a dollar a year ago is less than it is today. As a result, if you save your money without any interest earned, the value of your savings is actually decreasing over time.
Thus, people are forced to invest in different securities in order to combat the effect of inflation. Using inflation as a benchmark for your total return and diversifying your portfolio are the two best financial strategies during a time of inflation.
Using Inflation as a Benchmark
If you look at the inflation rate as a benchmark, you will be able to pick investments that are expected to earn more than the inflation rate. For example, if the current inflation rate is 4 percent, then your investments should project to earn greater than 4 percent. Whatever your investment is earning, you must then subtract the inflation rate to get the real rate of return.
Over the long run, stocks have had the best potential for returns that exceed inflation. There are many options of investing in the stock market to try to beat inflation. You may choose to handpick individual stocks to add to your portfolio or invest in a mutual fund. Purchasing bonds is another strategy for investment.
However, if you expect inflation to continue to rise, purchasing long-term bonds may not be a good idea. A good strategy is to invest in government inflation-adjusted debt. The federal government issues Treasury inflation-protected securities, or TIPS. These bonds have a fixed interest rate, but will continue to adjust the principal twice a year to the rate of inflation. They guarantee a rate of return that is above the inflation rate.
The key to any successful financial strategy is diversification. You must protect your investments from specific risks. As a result, you should create a mixture of low-risk, medium-risk and high-risk securities. The greatest slip-up you can make is tying up your assets in one place.
Because investment is a game of calculated chance, you need to hedge your bets in order to come out with the best return. For best results, you should create a mixture of inflation-adjusted bonds, short-term securities for liquidity and a diverse stock portfolio that takes the impact of inflation on the stock earnings into account.