How Your Investments Can Overcome Inflation
Figuring out how to invest against inflation ensures your investments retain value. Here’s how to get started.
A dollar is always worth a dollar…until it’s not.
That’s the nightmare of inflation, and if you’re not investing against inflation, your investments may not be worth as much in the future as they are now.
Here’s why inflation is so challenging for investors and how to invest against inflation.
The Challenge of Inflation
Money is one thing you can count on to retain value—a dollar will always be equal to a dollar. The problem is when your dollar doesn’t buy you as much as it used to.
This is called inflation, the decline in purchasing power of a currency over time. It is expressed as a percentage rate (2% inflation, for example) which is measured in the increase in the average price level of a selected basket of goods across the whole economy. As currency declines in value, prices rise as a single unit of currency buys less and less, affecting the overall cost of living.
To see inflation in action, just look at home prices over time.
In 1940, the median home value was $2,938. In 2020 dollars, that’s about $30,600. That would be fine if the median home value were still $30,600. But because of inflation, the median home value in 2020 is $361,225.
Central monetary authorities, like the U.S. Federal Reserve, know that people have to afford to live. So the Fed sets monetary policy to control the supply of cash and credit in the economy, keeping inflation within permissible limits (and keeping the economy running smoothly in the process).
Here’s the catch: inflation will never be 0%, nor will it become negative, because some inflation is a good thing. The unemployment rate and the inflation rate have an inverse relationship, so if inflation goes down, unemployment goes up. After all, if a single dollar buys more, it becomes more expensive to pay employees. Because of this, the Fed tries to keep inflation and unemployment roughly balanced for maximal economic health.
How to Invest Against Inflation
The problem, of course, is that inflation means the dollars you save today won’t be worth as much in ten years—and they’ll be worth even less in 40 years. This is why smart investing is so important.
If you can maintain a healthy growth rate on your investments, you can more or less balance out the impact of inflation. The trick is to plan ahead for inflation by choosing assets that outperform an inflationary market. In other words, you need to balance your portfolio with assets that retain their value even through inflation or assets that appreciate at a rate that matches inflation. This is a practice called inflation hedging.
In general, there are three types of investment assets that make good inflation hedges:
- Real assets
- Appreciation-oriented assets
- Variable interest assets
Let’s break it down.
Real assets, sometimes called tangible assets, are assets with intrinsic value due to their inherent properties. Gold, for example, has value because it is gold. A Van Gogh has value because it is a Van Gogh. And because real assets have intrinsic value, their value will continue to rise with the rate of inflation.
This is in contrast to nominal assets like traditional bonds, which are priced based on their fixed interest rate. Inflation basically eats the gains you would have otherwise received from interest.
Real assets are considered alternative investments, since they’re illiquid compared to stocks and bonds and their prices have little (if any) stock market correlation.
A great example of a real asset as an inflation hedge is fine art, which has long been used by wealthy investors for that reason. However, investors should keep in mind that fine art is unlike traditional asset classes in almost every way, and the most gains happen for art labeled as blue-chip. Unsurprisingly, blue-chip art sounds attractive as an asset: the term describes high-value art that is expected to hold steady or appreciate in value regardless of economic conditions, typically made by art world heavyweights on the scale of Picasso and Koons with a strong auction record.
The good news is that it’s now possible for ordinary investors to participate in blue-chip art investing (that’s what we do here at Masterworks).
Appreciation-oriented assets are not technically a unique asset class. The phrase refers to assets with a focus on appreciation, which is not the same thing as income—appreciation is the rise in value of an asset over time.
The best example of appreciation-oriented assets is stocks. That said, timing the market is a historically unsuccessful endeavor, and trying to hit gold on a single company is always destined to fail.
Your best bet is to diversify with stock products like index funds, which aim to track and match the performance of a segment of the market. The S&P 500 Index, for example, tracks the 500 largest publicly traded companies in the U.S. In other words, index funds don’t try to beat the market—they try to be the market. That’s great news for investors, since you get rapid diversification and generally reliable dividends.
Variable Interest Assets
Unfortunately, there’s no way to know how inflation will fluctuate. Compound interest is how investing can outpace inflation. Here’s the problem: if your asset pays a fixed interest rate, inflation will eventually swallow it.
Instead, look for assets that offer variable interest rates. This gives you a fighting chance to beat inflation over time.
Let’s Protect Your Portfolio Against Inflation
Hey, we get it—figuring out how to invest against inflation is not for the faint of heart. But it is possible to give your future self a fighting chance against inflation. You just have to invest smartly now, and take every opportunity to protect your portfolio gains.
Here at Masterworks, we’re on a mission to make blue-chip art investing accessible to ordinary investors. That way, you get the benefit of blue-chip art performance, but you don’t have to break the bank. In fact, our shares start at just $20 per share. Let’s invest in your future. Fill out your membership application today to learn more.