By Aaron Katsman

We are always complaining that prices that we pay for goods and services are always going up. Listen to the news and you will hear that the price of bread is going up, as is the price of gasoline. In addition, in order to escape the economic slowdown that has gripped the world, the US and almost every other country, is printing money 24 hours a day, 7 days a week to meet the trillions in new government spending.

We hear the term “Inflation” thrown around but what is it and how does it impact our investments?

Definition

Inflation is defined as a sustained increase in the general level of prices for goods and services. It is measured as an annual percentage increase. As inflation rises, every dollar you own buys a smaller percentage of a good or service.

The value of a dollar does not stay constant when there is inflation. The value of a dollar is observed in terms of purchasing power, which is the real, tangible goods that money can buy. When inflation goes up, there is a decline in the purchasing power of money. For example, if the inflation rate is 2% annually, then theoretically a $1 pack of gum will cost $1.02 in a year. After inflation, your dollar can’t buy the same goods it could beforehand.

Inflation and Investment

With little in the way of economic growth in sight, the threat of inflation seems mild. Many analysts say that it could take months before we need to worry about inflation. With all due respect to those analysts, we have actual data that shows the economy is inflating. Data just released in the US showed higher consumer prices, and in Israel, we have had 4 consecutive increases in the CPI (Madad).

If it appears that we are going to enter a period of high inflation, and what we said above is true that inflation erodes the purchasing power of your money, the question for investors is how to protect your portfolio against a spike in inflation?

There are 3 traditional inflation hedges that investors use to protect their portfolios. The general principal is to buy something now and sell it later, after inflation has increased the price of the product.

The most popular hedge against inflation is to buy gold. According to Blanchard Economic Research, “Gold is renowned as a hedge against inflation. The most consistent factor determining the price of gold has been inflation - as inflation goes up, the price of gold goes up along with it. Since the end of World War II, the 5 years in which U.S. inflation was at its highest were 1946, 1974, 1975, 1979, and 1980. During those 5 years, the average real return on stocks, as measured by the Dow, was -12.33%; the average real return on gold was 130.4%.”

In recent times the use of commodities aside from gold has gained in popularity. Corn and wheat are just some of other base commodities that increase in price during inflationary periods.

The problem with gold and other commodities is that they are not very liquid. For those investors who require a high level of liquidity, government bonds linked to the inflation rate may be the way to go. In the US these bonds are called TIPS (Treasury Inflation Protected Securities). TIPS come with the same guarantee as other US government bonds, and investors will see an increase in interest paid if inflation increases. While in the US, CPI-linked bonds are rather new, in Israel (where we have seen hyperinflation) inflation linked bonds are very popular.

Don’t wait for inflation to arrive to start thinking about protecting your portfolio, because by then it may be too late. Get a head start now and protect the value and purchasing power of your money.

Aaron Katsman is a licensed financial professional both in the United States and Israel, and helps people who open investment accounts in the United States. Securities are offered through Portfolio Resources Group, Inc. a registered broker dealer, Member FINRA, SIPC, MSRB, NFA, SIFMA. For more information, call (02) 624-0995 or email aaron@lighthousecapital.co.il.

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