How to deal with inflation with Covid mess and the war in Ukraine

In economics, inflation is defined as a gradual increase in the price of goods and services in a given economy. When the general price level rises, each unit of currency buys fewer products and services; as a result, inflation equals a loss of money's purchasing power. Here are a few ways inflation has an impact on the economy and individuals generally:

1.    Purchasing Power Declines: This initial effect of inflation is merely another way of expressing the same thing. Inflation is the loss of a currency's buying power due to an increase in prices throughout the economy.

2.    Spending and investing are encouraged: When one's purchasing power is dwindling, it's natural to want to buy now rather than later. Cash will only depreciate, therefore it's preferable to get your buying done and stock up on items that are unlikely to depreciate.

For consumers, this entails filling petrol tanks, stocking the fridge, purchasing shoes for the kids in the following size up, and so on. For businesses, it entails making capital investments that would otherwise be postponed under different circumstances.

3.    Increases Inflation: Unfortunately, the desire to spend and invest in the face of rising inflation tends to increase inflation, producing a potentially disastrous feedback loop. People and businesses are spending faster to limit the amount of time they hold their deteriorating money, resulting in an abundance of cash that no one wants. In other words, the supply of money exceeds demand, causing the price of money—the purchasing power of currency—to fall at an increasing rate.

4.    Inflation discourages saving: because the purchasing power of deposits erodes over time unless there is a vigilant central bank on hand to raise interest rates. Consumers and businesses alike are encouraged to spend or invest as a result of this possibility. The increase in spending and investment leads to economic growth, at least in the short term. Inflation's negative relationship with unemployment, on the other hand, shows a proclivity to employ more people, hence boosting GDP.

During inflation, many money-smart people think of the best places to put their money or make investments to make profits in coming periods or sustain the value of their money.

Longer-term fixed-rate debt is more susceptible to inflation than short-term fixed-rate debt because the effect of inflation on the value of future repayments is proportionally greater and compounds over time.

The investments that do best under inflation are those that are guaranteed to bring in more money or improve in value when inflation rises. A rental property subject to periodic rent increases or an energy pipeline charging rates connected to inflation are two examples. Let’s consider them better:

-       Real estate: Historically, real estate has done well during periods of increased inflation because the value of the property can rise. This means your landlord can raise your rent, increasing their income and keeping it in line with growing inflation. Real estate investments can be undertaken through REITs (also known as Real Estate Investment Trusts) or mutual funds that invest in REITs, in addition to homeownership.

-       TIPS (Treasury Inflation-Protected Securities) is an acronym for Treasury Inflation-Protected Securities. TIPS are actually pretty simple to understand, despite the fact that the name may appear to be a mouthful. TIPS are government bonds that move in lockstep with inflation. If a result, as inflation rises, so does the interest rate pay. Interest rates fall when there is deflation. "Because TIPS are indexed to inflation, they can help balance out your fixed income or bond portfolio," explains Diahann Lassus, a CFP and managing principal of Peapack Private Wealth Management.

-       Bonds: Bond investing may appear paradoxical, given that fixed-rate debt is often harmed by inflation. Inflation-indexed bonds, on the other hand, have a variable interest rate connected to the rate of inflation. Treasury Inflation-Protected Securities (TIPS), which are pegged to the Consumer Price Index, is a popular alternative in the United States.

The value of a TIPS investment rises in tandem with the CPI. Not only does the base value rise, but the amount of interest payments also climbs as the base value rises, because the interest paid is based on the base value. Foreign types of inflation-indexed bonds, such as those issued by other governments, are also available. Maintaining cash in a CD or savings account is akin to keeping money in short-term bonds.

-       Stocks: Stocks have a good chance of keeping up with inflation, but not all shares are made equal when it comes to doing so. Inflationary periods, for example, tend to beat high-dividend-paying stocks like fixed-rate bonds. Investors should look for companies in the goods-producing category that can pass on higher input costs to customers.

-       Commodities: Prices for basic commodities such as oil, metals, and agricultural products tend to rise in lockstep with inflation, making them a strong inflation hedge. Commodities, on the other hand, can be exceedingly dangerous for investors. Commodity prices are mostly determined by supply and demand, which can be highly unpredictable. This, combined with the fact that investors are taking on leverage, makes them a dangerous investment: The chances of winning are high, but so are the chances of losing.

-       Cryptocurrency: Bitcoin is sometimes referred to as 'digital gold,' and its restricted supply should theoretically safeguard it from inflation. However, the jury is still out on whether it would be a suitable long-term inflation hedge. Bitcoin's recent volatility should be a cautionary note to investors. If anything, I believe it underlines the difficulty of incorporating Bitcoin into a balanced portfolio.

Investors have several options for protecting themselves against inflation, but TIPS are the safest investment. Otherwise, take advantage of an inflation spike to assess your overall investment performance and allocation to ensure it is in line with your objectives.