Inflation is a term used in economics to mean the general increase in prices. When the prices of goods and services increase, the overall purchasing power of money decreases, which means that the value of a currency decreases.
Why do we as investors continually monitor the rate of inflation?
Some stocks behave differently than others during spikes in inflation. Investors can monitor the likely performance of a stock by looking at the trend of the stock’s historical data. Investors should ensure that, as part of their portfolio, some assets are more resistant to the fluctuation of inflation.
The risk is that the higher the rate of inflation, the lower the real return on your assets. To determine the real rate of return for businesses, you take the annual return earned and subtract the rate of inflation.
Are there any investments that can be considered during a phase of high inflation?
1. Companies with low debt
Gielie Fourie, a research analyst at Overberg Asset Management says to avoid companies with too much debt on their balance sheets. This would make sense, especially when she considers that with inflation, interest rates tend to rise; this is how the Federal Reserve counteracts the rate of inflation. This means that there will be higher interest costs for businesses if they have a large amount of debt on their balance sheet.
2. Companies that can shift the burden of inflation onto consumers
During the 2022 inflation surge, many companies reported lower profits due to rising costs within their companies. However, some companies can raise their prices relative to their competitor and still make sales. These companies are monopolies in their industry or part of a handful of competitors. Companies with a clear competitive advantage could also fall into this category. By investing in companies that can maintain their profit margins despite rising costs, your portfolio could be more resilient in times of inflation. Defensive sectors such as utilities, consumer staples, health care and telecommunications can pass costs on to consumers and tend to do better in times of high inflation. Seek the guidance of a financial advisor before making any investment decisions.
The next section shows that investors may consider alternative asset classes, such as real estate and commodities, in times of high inflation. If prices rise, real estate and commodities are likely to rise as well.
3. Real estate
Real estate companies are publicly traded if you are looking for an alternative to buying a physical property. A good option to invest would be a real estate company that is listed as a real estate investment trust (Reit). You also have the option to branch out into physical real estate. Real estate accounts are more than rental houses or apartments, consider offices or commercial properties, or think about investing in locations around the world.
You can search for raw materials or invest in companies involved in the raw material industries. As a refresher, commodities would include metals (gold, silver, platinum, copper), energy, livestock, and agriculture. To learn more about energy as a commodity investment, you can read our south african report on Investing During Inflation, written June 28, 2022. When analyzing commodity stocks, it is good practice to consider the financial health of the company you are investing in. This is a rule for every purchase and every scenario, not just commodities.
An experienced investor is not surprised by inflation. Sound investors simply look at the big picture and make sure their investment strategy is set up to continue to build wealth in times of inflation. This does not count as financial advice, as many factors would first need to be evaluated for each individual investor.