Inflation occurs when demand exceeds supply for goods and services. Inflation does not continue unless the government increases the money supply, reports Boston University. Inflation creates uncertainty and reduces the value of investments, affecting retirees and fixed-income investors most. Social Security has built-in protections for inflation with the cost-of-living increase. Investments routinely have no inflation protection, but inflation-protected securities, precious metals investments and residence purchases can decrease anxiety and help investors cope with inflation.
1. Hold less cash and buy stocks for essential products. An understanding of basic economics provides your best investment strategy. As the purchasing power of the dollar decreases with inflation, cash sees the most erosion. Economists often recommend holding less cash in anticipation of inflation. Some economists suggest that investments should include stocks from firms that make essential products such as groceries or medicine to hedge against inflation. The public demands essentials at any price.
2. Protect against inflation or deflation with inflation-protected securities from the U.S. Treasury. Treasury inflation-protected securities (TIPS) from treasurydirect.gov protect against inflation or deflation. In the event of deflation, you receive your full principal at maturity. The yield and coupon payments of TIPS tie to the consumer price index. These securities are safe investments with low yield based on the real rate of return. I-bonds are another treasury issue with rates tied to inflation. The U.S. Treasury bases interest for the six months on two figures -- a fixed rate and an inflation adjustment. You must hold an I-bond for a minimum of 12 months and you lose 3 months of interest if you cash it in less than five years.
3. Purchase precious metals. Portfolio managers suggest investing in gold to hedge against inflation. Gold may increase in value, but precious metals do not earn interest or dividends. You need a safe place to store any gold you purchase, costing you money for a safe-deposit box while you wait for inflation. Silver requires about forty times the storage room for the same dollar value, discouraging many investors from the silver market.
4. Buy a residence. Inflation affects renting a home, and individuals who choose to rent may see an increase every year. Your personal residence can be a hedge against inflation if you purchase a home and acquire a fixed-rate mortgage. You lock in the price of the home at purchase and house payments for principal and interest for a purchased home will be the same amount in 20 years unless you refinance. Taxes and insurance may increase the escrow requirements. A change in real estate values does not affect you because you are living in the home, not selling it.
- Inflation-protected investments from the U.S. Treasury are low-yield securities because they are low risk.
- Home values do not always increase, but you are protected against inflation so long as you live in the home and make the payments. Refinancing affects your inflation protection, particularly if you increase your loan.
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