Inflation can cause a real scare among investors when it starts to rise unexpectantly, which should balance any sound investment strategy through the use of hard assets. Unlike other investments, hard assets can be a powerful bet against rising inflation while also providing you with a form of income at the same time. Referred to sometimes as real assets, hard assets include a wide range of commodities such as precious metals, natural resources, and, of course, real estate.
Today’s post looks at how inflation works and what savvy investors can do to protect themselves against it. Play your cards right, and you may even see strong gains as a result of increasing inflation.
What Causes Inflation?What Causes Inflation?
Inflation is driven by two primary causes, economic growth and monetary debasement.
Economic GrowthEconomic Growth
Any economy going through a rapid period of growth will see a rise in the costs of both goods and services. As demand increases for products, so does the cost to produce them. This is due to rising wages and the costs of materials. With increasing demand comes the need for more materials and employees. Increased competition raises the costs for these materials, which get passed onto consumers through higher prices. Falling unemployment means workers can lobby for wage increases, and employers will begin to offer higher pay to attract employees away from their competitors.
All of this leads to a snowball effect that generates higher prices and a fall in the purchasing power of money. Generally speaking, this isn’t bad, so long as wages, interest rates, and other economic factors also rise in sync with inflation. The problem arises when these other factors are not in sync or only adjust after a significant time lag. When that happens, it can lead to blurred price signals, unintended redistributions of purchasing power, and difficulties in long-term planning. All of which can be aggravated through monetary debasement.
Monetary DebasementMonetary Debasement
When a country prints more money, this also leads to a fall in the currency’s purchasing power. This often occurs during a financial crisis when banks begin to lower interest rates to increase their lending potential. The US dollar’s purchasing power is measured through the Consumer Price Index (CPI) or Personal Consumption Expenditures (PCE) in the US. These indicators evaluate the change in prices for consumers and determine whether the economy is going through inflation or deflation. Generally, the US Federal reserve aims for an annual increase in inflation of 2% based on the PCE rates.
Recently, the CPI rose by 0.8% in April, after rising 0.6% in March. In total, CPI is now up 4.2% since April 2020, the sharpest increase since 2008. The coronavirus pandemic explains much of it, but some economists debate whether it signals a wider trend. Concerns like this and the recent disruptions to supply chains have generated a lot of market volatility.
In times like this, investors need to look for ways to protect themselves against runaway inflation. For that, nothing succeeds better than a hard asset.
What is a Hard Asset?What is a Hard Asset?
Unlike soft assets, like stocks and bonds, hard assets are said to hold intrinsic value. This means they are physical commodities that can be sold or traded for other goods and services. For instance, a fleet of trucks can deliver consumer goods or a rare metal like gold that can easily convert into cash. They can also use them to manufacture goods like oil or natural gas.
While paper currency can devalue almost zero, hard assets can maintain their intrinsic value to provide a fundamental human need. There’s rarely going to come a time when they’re not in demand, and their values generally rise in tandem with any fall in the values of soft assets. As the common idiom puts it, they’re as safe as houses.
The Value of Real EstateThe Value of Real Estate
Concerning real estate, both the land and the structure itself hold intrinsic value. This value is based on local supply and demand. Less land and more demand mean a high value, which is why you’ll pay far more for a small lot in Manhattan than you would for a similar-sized lot in rural Kansas. The building itself will be limited by the size of the lot and the quality of the materials used. Any increase in the cost of materials will mean a corresponding increase in the cost to build a similar property. So long as demand remains the same, this will increase the property’s value.
Additionally, you can lease out the property to earn income through rental payments compared to other hard assets. A property’s rental value can also increase depending on local supply and demand, just as its intrinsic value rises. For these reasons, real estate has always been the go-to investment strategy during periods of inflation. There really is no better way to hedge against these risks and even increase the worth of your investments.
Getting into Real Estate InvestingGetting into Real Estate Investing
If you’ve ever been a tenant, the life of a landlord might not seem so appealing. Constant calls to fix broken water heaters, pest infestations, and troublesome tenants being some of its worst features. Fortunately, there are many ways to approach real estate investing without becoming a landlord. You can get started right away with any of the following methods:
1. Buy REITs1. Buy REITs
Real estate investment trusts offer one of the easiest ways to get into the game without handling any physical properties. They work a bit like stock investments in that you can invest as much as you wish into a mutual fund that owns commercial or residential properties. In return, you can get high dividends that can either be used as a retirement fund or reinvested to increase your investment further. Just be aware that REITs can be complex and aren’t without risks of their own. Therefore, any new investors should stick to publicly traded REITs that they can purchase with the help of a real estate brokerage.
2. Online Real Estate Investing Platforms2. Online Real Estate Investing Platforms
Real Estate developers are always in need of investors, and by using an online platform, you can get started right away. These platforms work by connecting developers with investors who are looking to finance projects. In return, the investor receives a monthly or quarterly distribution based on the amount of risk they have taken. However, be aware that these can be highly speculative and illiquid. They’re also usually only open to accredited investors with a net worth of $1 million or more.
3. Investing in Rental Properties3. Investing in Rental Properties
A common house hack for first-time buyers is to purchase a multi-unit home and rent out one of its rooms to cover the investment costs. When done right, the kind of setup can cover all of your expenses and even bring in a little extra in rental income each month. This can make for an easy entry into the real estate world and open the doors to more investments in the future.
4. Become a House Flipper4. Become a House Flipper
If you’ve ever watched HGTV, then you’ll know what this is like. House flipping can be incredibly lucrative for those who know how to do it. But it can also be a financial disaster waiting to happen if you don’t know what you’re doing. Forget the ease with which TV shows make it look; this investing requires rock-solid dedication, hard work, and significant starting capital. Many beginners choose to find a partner to help them get started.
Final ThoughtsFinal Thoughts
The best investments are always the ones that best serve the investor. Think about your own goals for the future and let those guide you in your investment decisions. The great thing about real estate investing is choosing how committed you want to be to the game. Growth opportunities are also practically unlimited as one purchase invariably leads to another. If you’re interested in becoming a real estate investor, schedule a consultation with an ELIKA real estate agent.
Even when you’re only in the dreaming phase, our agents can provide all the information and advice you’ll need so you can enter the market with complete confidence.