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Protect Yourself Against High Inflation

Finance

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3.2.21 |

Joseph Darby

8 ways to fight back against spiking inflation

“When I was your age, a loaf of bread was 30 cents!"

Has someone near you ever said a similar thing to you? Or better yet, maybe even you have started saying things like that? You might remember when a movie ticket was $5, milk was a dollar or two, or when young couples could easily afford houses.

Inflation is the culprit for these changes, and it's going to occur whether you like it or not. But, there are things you can do to protect yourself from it. Let's take a closer look at some techniques you can use to help make sure you're not losing money to inflation.

What is inflation?

Strictly speaking, inflation is when the government expands the country’s money supply through the Reserve Bank of NZ (RBNZ) — especially when the money supply grows faster than the economy (as measured by GDP).

In days gone by, this was accomplished by printing dollar banknotes and injecting them into the economy, but nowadays the same result is accomplished by adjusting bank balance sheets with just a few keystrokes.

Of course, most people don’t track the national money supply. Instead, when they think of inflation, they think of the symptoms rather than the cause. These symptoms include:

Rising CPI (Consumer Price Index, how the government officially measures inflation based on the prices of consumer goods such as groceries)
High housing prices
Rising wages

Inflation impacts consumers’ everyday lives — the costs of normal everyday transactions, like petrol and food. But it also impacts the value of savings and investments in significant ways.

Not all inflation is bad. The RBNZ’s monetary policy aims for two percent annual inflation, which should result in a stable upward climb in CPI. However, right now NZ’s rate of inflation is six percent, and remember this measure doesn’t even include the increased cost of housing! (Which means the real rate is surely higher). It’s not just NZ feeling the effects of inflation either, take a look at some other countries:

USA, 7.5%
UK, 5.5%
Canada, 5.1%
Brazil, 10.4%
Holland, 6.4%
South Africa, 5.7%
The EuroZone, 5.1%

How does inflation impact savings?

Inflation is sometimes called a “hidden tax,” because it degrades away consumers’ purchasing power without actually taking dollars out of their pocket. When inflation is high, dollars become worthless over time, and as investors can buy less and less with the same dollar — they have to pay increasing sums for the same thing.

In addition to impacting consumers’ day-to-day expenses, inflation wreaks havoc with people’s savings. Any money that consumers’ hold in bank cheque or savings accounts, or term deposits, yields virtually no interest. Money held in savings can’t keep pace with even a modest amount of inflation.

But, this is a double-edged sword. When consumers owe money to a bank or other lender, and inflation picks up, the value of the money they owe declines in real terms over the life of their loan. So, if you have a good ability to borrow, you can obtain lending (or, even more lending if you already have some) then pay back your loan over time with dollars that are worth less than when you borrowed them.

How does inflation impact investments?

While inflation hurts savings, it can help the value of investments — especially a certain class of investments, like real estate, which should serve as a hedge against inflation.

Granted, there are other investments that tend to perform poorly in times of inflation. Financial companies like banks might be one example — these are companies that lend money to businesses and consumers, and dollars that they’re paid back are worth less than the ones they lent.

Plus, quite often, when inflation starts in earnest, the RBNZ ends up raising interest rates to combat inflation. This slows down the housing market, car sales, etc., and businesses that rely on those sales might not do so well.

But, overall, when inflation picks up, being invested is better than not. When inflation is high, it is often said that cash is trash.

Eight tips to protect against high inflation

So, if you weren’t already, you should understand inflation is here.

But what should you do about it?

1. Cash is trash

Unless there’s a very good reason, investors should avoid holding much cash (including savings accounts and term deposits), because during periods of inflation, it declines in value every single day. You’re almost always better off holding investments in times of inflation, no matter what you invest in.

2. Buy real estate (property)

Real estate is probably one of the best assets to own in times of inflation — not only because values tend to increase, but also because it’s easy to finance purchases with money that will decline in value as you pay it back. Whether you’re buying a residence, rental property, etc., it’s better to buy before inflation kicks in and the RBNZ hikes up interest rates (assuming you can make the repayments on any debt you take out).

3. Buy shares

While prices can fluctuate during times of high inflation, shares are another great investment during such times. This is because shares are just tiny slices of companies, and most companies have the ability to simply put up their prices to keep pace with inflation.

You might hold shares directly, or through managed investments such as managed funds or a KiwiSaver Scheme.

4. Are metals golden?

Precious metals, as traditional stores of value, tend to do well when inflation is rampant. Over recent years they’ve been less effective at this versus 40 years ago, though there are still more than a few “gold bugs” (people who fanatically invest in gold and precious metals) who will vocally suggest that you invest everything you’ve got into gold, silver, and other metals! If you’re really worried about inflation, a small allocation to these assets could still be a great way to diversify part of your portfolio.

5. Fill up your tank

If inflation picks up any further, oil is going to get even more expensive, which we all pay for at the pump. We’re not suggesting you buy oil drums and bury them in your backyard. But if you think inflation is going to pick up, don’t wait on expenses like fuel. If you can afford it, maybe it’s time to go splash out on an electric car?

6. Make purchases sooner rather than later

While we’re talking cars, if you are a car-owner and go online to search for the same model you might notice something more than a little unusual – the same model of car may now be worth more than you paid for it.

Trademe’s sales director even recently reported “…many Kiwis [are] actually making money on their used cars.” Why? Inflation, of course!

If things are only getting more expensive, it might make sense to make any major purchases sooner rather than later, including vehicles or any other big purchase.

Keeping in mind that cash is trash, the wealthiest among us are already out buying investment-grade art, or basically anything to spend the cash they have. The logic is that the investment-grade art will go up in price, or at least hold it’s value in real terms, unlike dollars in the bank.

7. Cryptocurrency

Nobody knows how cryptocurrencies might go during times of high inflation. They simply haven’t existed long enough for sound data.

But, cryptocurrencies do have a few advantages over government-backed fiat currencies (currencies that are not backed by gold or other real commodities). First, governments looking to manage their debt by printing more money can’t manipulate cryptocurrencies.

The problem with cryptocurrencies is that their underlying value isn’t clear. There is surely some inherent value in an anonymous currency not controlled by any government, it’s just no one knows precisely what that is.

8. Refinance

If you already own a home or investment property, you may want to refinance while interest rates are still reasonable. You’ll repay your loan with dollars that are worth less than those you borrow now, and you’ll lock in a low interest rate before the RBNZ raising rates to fight inflation. (Note: there’s no guarantee this’ll happen, it’s just a best guess based on what many commentators are saying).

The bottom line: protecting yourself from high inflation

Inflation is when the purchasing power of the dollar declines because of new money being created and entering the economy. This can destroy the value of consumer savings, but also have a positive impact on investments — especially the values of certain assets that serve as hedges against inflation.

So, if you want to protect yourself against inflation, this is the time to avoid holding savings in cash. Instead, you should consider investing in shares, buying a house, or refinancing before inflation gets even worse.