One of the realities of our economy is inflation. Inflation, which is a rise in prices (or a reduction in purchasing power) has a very real effect on your finances. As inflation increases, your ability to get more for your money decreases. This means that it takes more money to buy the same amount of product or service as you could buy a few years ago. Unfortunately, there is almost no way to stop inflation. Hedging against inflation, is something you can work on so that your wealth grows at pace with inflation — or beats it.
Playing It Safe: Capital Preservation
If you want to preserve your earning power by keeping pace with inflation, you can engage in a strategy known as capital preservation. With this strategy, you try to encourage your asset growth to match inflation. That way, your buying power remains intact, and you don’t take a lot of risks.
Some of the most popular vehicles for keeping pace with inflation are I-bonds and TIPS. These are bond securities backed by the U.S. government. They are adjusted to keep pace with inflation so that you earn interest at the inflation rate. (We’ll leave whether or not CPI, which is used in adjustments, is a true measure of inflation for another time.) You can also look for high-yield CDs, savings accounts and money market accounts that can sometimes keep pace with inflation and help you preserve capital while keeping your money safe in an FDIC-protected institution.
Riskier Opportunities: Stocks, Commodities and Currencies
Many people aren’t content to keep pace with inflation; they want to beat it. In such cases, higher risk comes with the chance of higher reward. Stocks represent one of the most common ways that people hedge against inflation. Investors hope to earn enough money to help them live comfortably, even taking into account inflation. Dividend stocks can provide you with a helpful way to beat inflation while cultivating an income stream.
Commodities and currencies are considered riskier investments, and they can do even more to hedge against inflation. Indeed, gold is often seen as the hedge against inflation, since it often gains value as the dollar loses it (but not always). Oil and other energy commodities are also considered good hedges against inflation. Currencies other than the dollar can also be used to hedge against inflation. However, before getting involved in such trading, it is important to understand the risks.
Taking Matters into Your Own Hands: Start a Business
Another way you can beat inflation is to improve your earning power. You can start a business that grows along with inflation, helping you earn more even as prices rise. There are a number of opportunities to make more money, thanks to technology and the Internet. You can start a business to provide yourself with income through the years, or you can start one with the intention of selling. Either way, there is the chance that you will be able to beat inflation with your own business. However, you do have to understand that there are risks involved in starting a business as well. You could lose everything if you aren’t careful.
In the end, there are many different strategies for hedging against inflation. Figure out what combination is likely to work best for you.