During the COVID-19 pandemic, inflation rose dramatically. According to Pew Research, "The Consumer Price Index, the most widely followed inflation gauge, increased 7 percent from December 2020 to December 2021—its highest rate in nearly 40 years." That's a staggering number, and it has implications for consumers and investors in every sector.
While you care about inflation for many reasons, as an investor, you probably have one question: How should inflation impact my savings strategy, and how should I reposition my portfolio as a result of it? In short, what should be my inflation investment strategy?
In this article, we'll answer this question by explaining how inflation works and why it should push you to make investments in anything (especially real estate) that tracks with or exceeds the rate of inflation.
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What Is Inflation and How Do You Know When It's Happening?
Before we discuss what kind of inflation investment strategy is best for you, it's important to understand what inflation is and its investment-related implications. Inflation is what happens when the purchasing power of your currency goes down over a period of time. When a unit of currency buys less than it did in prior periods, inflation has occurred. But that's an academic answer. That's not how inflation feels. That's not how you know when inflation is happening.
So, how do you know when inflation is happening? From a real estate perspective, you know it's happening when the house you want to buy cost $500,000 last month and $600,000 this month. It happens when the property across town that you've had your eye on now seems out of reach. While an individual seller can inflate prices on their own, if it's a general trend for all houses and properties in a particular market, that's when you know inflation is occurring.
In the world of real estate, we can get even more specific to discuss inflation-related indicators. First, you'll notice mortgage rates going up. This is the most obvious indicator. In the State of Washington, for example, a 30-year fixed-rate loan has increased nearly 1 percent over the last several months. That's fairly significant inflation.
Second, real estate asset prices usually increase during periods of inflation. Most experts agree that this is due to low-interest rates. Investors are looking for a good return on investment, and if interest rates are low, low-risk methods like savings accounts and government bonds are not going to deliver. Instead, investors buy up real estate to get something out of their money, thus inflating the real estate asset prices during inflationary times.
Third, construction materials and labor costs normally increase during a period of inflation. This happens whenever inflation occurs, but we've seen this, especially during the pandemic. Because of COVID-19, international manufacturers have closed factories that produce these materials. This decreases the supply, and whenever supply decreases on a product, the price of it goes up.
How Does Inflation Impact Your Savings Strategy?
Inflation is not just an economic trend. It affects everyday life. Specifically, it will affect your savings strategy and will require you to have an inflation investment strategy.
If the inflation rate goes beyond the interest earned on a savings or checking account, then you're losing money as an investor. For example, let's say you have $5,000 in a savings account and it has an interest rate of .06%—a paltry rate, to say the least. In one year, that savings will increase by three dollars, from $5,000 to $5,003. If inflation goes from 6% to 7% during that same year, therefore to keep up with inflation you would need a 7% annual return, i.e., $5,350 just to keep up with Inflation. However in this case, the interest rate on your savings account is not keeping pace with inflation, so you're losing money on that investment.
Choose High-Yield Investments During Inflation
Your inflation investment strategy, therefore, should be to take that money you normally have in low-yield savings or checking accounts and invest it in something that has a higher yield or that tracks with inflation.
There are a number of wise places to invest during a time of inflation. These include Treasury Inflation-Protected Securities (TIPS), government bonds that track inflation, high-yield dividend-paying stocks, precious metals, real estate, and cryptocurrency (although it is riskier).
Why Real Estate Is a Good Investment Option During Inflation
While we could go into significantly more detail on all of these items, let's focus on what kinds of real estate opportunities make sense for your inflation investment strategy.
First, there's the option of just buying a home or single real estate property. Why might buying a home be a good idea? It's important to understand the logic of real estate investment during inflation. On the one hand, if inflation is occurring, that means it's going to be more difficult to buy a $600,000 house that just last year was $500,000. So, while we can say that it's smart to invest in real estate during inflation, that doesn't mean it's going to be easy.
However, if you can afford to invest in real estate, doing so during inflation is typically a wise move. The price of real estate tends to track inflation. To use the $5,000 example again, if you put that money into a house instead of a savings account, and if inflation does increase by 1% over the course of the year, you will earn .94% more than you would with the savings account (at a .06% interest) if the price of the house tracks with inflation. In real dollars, your $5,000 would become $5,050 instead of $5,003 (the savings account example).
Using this model, not only does it make sense to invest in real estate during inflation, but it also might make sense to sell your property when inflation gets under control (or deflation occurs). This depends on your investment and savings strategy, whether you want to hold on to your property for the long term or not. Also, you can keep an eye on long-term inflation trends, but you can also just look at the real estate price trends in your own market to determine whether it's a good time to sell. Regardless, if you're interested in making money off your investment, the time to sell is when you see the real estate prices going down for a period of time (which in itself is relatively rare).
Second, outside of buying a home or property, you can invest through a Real Estate Investment Trust (REIT). These trusts are "companies that own or finance income-producing real estate across a range of property sectors." So, instead of investing in a single home, you can invest in a company that owns or finances many properties, and you will receive dividends from the trust as payouts. The trust acts as a middle man, much the same way a mutual fund acts as a middle man between you and the stocks and bonds it manages.
As an investor, the REIT may be more attractive than investing in a single home, since you can rely on the expertise of the managers of the trust. Instead of trying to research and determine which single home is a solid investment, you can count on professionals who commit to this full-time.
However, picking the right REIT will take some research as well. First, you can buy shares in a REIT, just like you would buy shares in any publicly traded stock. You may also buy shares in a REIT mutual fund or exchange-traded fund. Millions of Americans live in homes financed through REITs. In addition, many 401(k)s have REIT allocations as part of their funds.
Most experts agree that the best REIT allocation for your investment portfolio is between 4 and 15 percent, but of course, this depends on your specific investment strategy.
While REIT investments are attractive during a period of inflation, it's important to remember a few downsides. First, the share prices on the funds may go down if other high-yield assets are in demand. In particular, REITs often buy Treasury securities if interest rates are high. Second, REITs pay property taxes, which can be as much as 25% of the trust's operating expenses. Third, REITs charge management fees. In other words, your investment in a REIT will not only go toward profit-maximizing benefits. Finally, you'll need to pay taxes on the dividends that you earn. REIT dividends are considered ordinary income, which is taxed at a higher rate than your typical dividend.
Take Advantage of Inflation by Investing in Real Estate
In conclusion, it's one thing to say inflation is bad for consumers. It certainly is. Your money just doesn't go as far as it did before this inflation hike. However, inflation can be a significant opportunity for real estate investors, if you find properties or real estate funds that work for your inflation investment strategy.
Investing in real estate does not have to be a difficult task. Many opportunities do not even require a large initial investment or the ownership of the real estate to participate in the market.
EquityBrix can help you grow your wealth through our fractional real estate investment platform. Our team marries the needs of investors and real estate developers by providing opportunities for above-market returns. EquityBrix is committed to creating high-yield investment offerings, and we can help guide you through the new era of real estate investing.
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If you are looking to grow your wealth and diversify your investment portfolio by learning about innovative ways of investing in real estate go to EquityBrix, or contact us for more information, or sign-up for the EquityBrix Newsletter.
*Disclaimer: EquityBrix is not an investment adviser. This information is for educational purposes only and does not constitute investment or tax advice. It’s important to be informed and to make your own investment decisions or do so in consultation with a professional financial advisor. Under no circumstances should this material be used or considered as an offer to sell or a solicitation of any offer to buy an interest in any investment. Any such offer or solicitation will be made only by means of a written online prospectus relating to the particular investment.
FAQs
What should you invest in during inflation?
According to experts, the safest place to put your money during a time of inflation is Treasury Inflation-Protected Securities (TIPS). TIPS are government bonds that track inflation. Therefore, when inflation goes up, the interest paid on the loan goes up. When deflation occurs, the interest paid goes down.
Most advisers agree that cash is an overlooked but high-quality option for investment during inflation. Finding some kind of high-yield cash account, like a money market fund, is a smart option since these cash investments tend to track with inflation pretty well. Also, they are more accessible if you need to withdraw some money during a crisis.
It is usually better to invest in short-term bonds than long-term bonds. Short-term bonds tend to be tougher during times of inflation surges, and they also are more accessible than long-term bonds if you need to take money out.
Real estate investing is typically an attractive option during inflation surges. For example, if you can afford to buy some real property, the price of that property will go up, allowing you to charge more for rent as a landlord. REITs are also a great option during inflation.
Finally, gold tends to be a solid long-term strategy during periods of inflation surges. It tends to keep up with inflation over years and even decades, even if it doesn't in the short term.
How is inflation measured?
Inflation is simply the increase in the prices of goods and services in your country. This is typically measured with the Consumer Price Index (CPI), which itself measures the purchasing power of the people in a country. The CPI will measure how much it costs to buy a particular category of goods and services consumed by households. For example, perhaps the price of oranges in the United States rose 5.3 percent from December 2020 to December 2021. That's a measure of the CPI of oranges, and it also indicates that inflation has occurred since the price has gone up.
Is it good to invest during inflation?
It is good to invest during inflation if you invest in the right things. As mentioned above, anything that tracks inflation (like TIPS) is a strong investment during inflation. Most experts agree that stocks tend to perform better than bonds during inflation. Investments in stocks that are tied to necessities (like food) tend to be smart since the demand for them tends to be the same regardless of inflation rates.
How do I protect my money during inflation?
In order to protect your money during inflation, there are some things you should do and some things you should not do. Experts advise that you should not purchase a car, since inflation on cars is outpacing general inflation numbers. Also, if you already own a car, be content that it gets you from point A to point B, and when inflation numbers go down, that may be a better time to buy a luxury vehicle. You should also not put excess cash into savings accounts, since those accounts pay very little in interest. Because of that, you'll feel the sting of inflation even more, since the growth of your savings isn't keeping pace with inflation. It's also wise in general to spend less during a time of inflation, especially if the items are not necessities.
Instead of putting your money in luxury items and savings accounts, advisers recommend putting your money in smart investments. In particular, it's wise to build a diverse portfolio of investments that will track inflation. Series I savings bonds and TIPS are both strong examples of these. Real estate and REITs can also be wonderful options during periods of inflation.
