There are many definitions of inflation, but in easy words, inflation is a decrease in the value of unit currency. To understand this phenomenon lets us consider the number of candies one can but with one dollar. Today one can buy 2 candies for one dollar but ten years ago, one could have bought ten candies for one dollar. Now, the dollar is same and the candies are same, what changes here is the value of dollar.
From the above example, we can also learn that inflation is directly influenced by time and is continuously growing. In addition to the permanent rise in inflation by time, many other factors causing inflation to raise temporary at the domestic or international level. Inflation is generally categorized into Demand pull inflation and Cost push inflation. In Demand pull inflation the economy is at or close to full employment, and it leads to an increase in the price level. When firms reach to its full capacity, they respond by putting up prices leading to inflation. In Cost pull inflation; if there is an increase in the costs of firms, the firms passes it on to consumers.
Cost push inflation can be caused due to Rising Wages, Import Prices, Raw Material Prices, Profit Push Inflation, Declining Productivity and Higher Taxes. Rising House Prices and Printing More Money also contributes for rising inflations.
There is no proven way to beat Inflation as there always lays some risk while investing for future. But following are the least risky ways to save you from inflation.
Invest in Stocks
Despite the lack of confidence that most people often have about stocks, owning some equities can be a very good way to combat inflation. Corporations will sell their goods at increasing prices, which will lead to elevated revenues, earnings, and inevitably, stock prices.
Hence, some of the best companies to own during inflation would also be those companies that can increase their prices naturally during inflationary periods. One should attempt to seek out the lowest cost producer. Look for businesses like commodity companies or healthcare names that possess the strongest profit margins. Finally, never underestimate the value of dividends during periods of inflation.
Invest in a Home
Real estate is a great investment when done for the right reasons. The problem in real estate occurs when one’s goal to trade a home versus buying a home to live in. Although many experienced real estate investors are able to find hidden values in properties, most individuals should focus on purchasing a home with the intent of holding it, even if for only a couple years. Real estate investments usually do not come to fruition over several months or weeks, but normally involve an extensive waiting period in order for values to increase.
Like land, home prices tend to increase in value on an average year-over-year basis. Real estate bubbles are usually followed by correctional periods, sometimes causing homes to lose over half of their value. But on average, housing prices tend to increase, counteracting the effects of inflation. Rather than holding money in a saving account, which will cause a major loss in purchasing power by retirement, real estate investments have the opposite effect.
These bonds are a great way to beat inflation as they are designed to protect both principal and interest.
The basic mechanism of an IIB is quite easy to understand. Assume that the annual coupon, that is, the amount the investor receives at the end of the year on his bond investment, is 7%, and he has invested Rs 1,000 (his principal); in this case, he originally would have been paid Rs 70 at the end of the year. However, assume that the inflation index for the year is 10%. Through an IIB, the 7% coupon is then applied to the new principal of Rs 1,100 (10% of Rs 1,000 + Rs 1,000), which comes to Rs 77 plus Rs 100 increment on the principal. Thus, the investor is sure to generate a return higher than the inflation rate.
Asset allocation is critical. In this, one can look at an opportunity is to diversify globally. This will make your portfolio more stable and less vulnerable to domestic volatility and inflation.
Invest in Yourself
By far, the absolute best investment you can use to deal with an uncertain future that may include higher prices is to invest in yourself. Nothing is more effective in combating inflation than investing in yourself in order to increase your future earnings power potential.
This investment begins with getting a quality education and then constantly striving to learn new skills that will match those most needed in the future. It’s not mere coincidence that higher the level of education, higher the pay and greater the chance for employment. Further education allows one to not only inflation-proof his/her salary, but also recession-proof his/her career.
More than stocks, bonds or houses, investing in oneself is the easiest and most effective way to combat inflation, and any form of economic turmoil is to increase your future potential earnings power by investing in yourself today.
By learning from the past experiences and by understanding the algorithm of the causes and various effects of inflation, one can at least lower the effects of inflation.