The Best Investments in Times of Inflation
The feeling you get after eating Cinnabon.
Also, a term that refers to the general increase in prices.
Inflation is said to occur when a dollar today purchases less than what it used to be able to purchase.
Inflation rose more than expected in August even as gas prices helped give consumers a little bit of a break, the Bureau of Labor Statistics reported Tuesday.
So, the question that suggests itself in this environment is:
Where should investors put their money when inflation is high?
We’ll examine some of the most popular options in this article.
Cash is a tough position to be in considering the definition of inflation is that cash is losing its purchasing power.
Specifically, in the U.S., the U.S. dollar lost 8% of its purchasing power in the last 12 months.
Mind you this is a lot better than most other currencies in the world.
Turkey reportedly registered an annual inflation rate of nearly 70% during this same period.
Still, cash holders in most currencies did a lot better than say ARK Invest holders (Ticker: ARKK) who are down more than 60% in the last 12 months.
Point being, cash isn’t necessarily a horrible option even in times of inflation. It all depends on the alternatives that are available to you.
There is also a cash-generated return that is often overlooked: peace of mind.
When the sky is seemingly falling, having enough cash to cover your expenses for the next 6 months will work wonders on your state of mind, stress levels and your ability to make good decisions including investment decisions.
Stocks are a mixed bag in periods of high inflation. To the extent a company can raise the prices of its goods and services when its expenses rise, it may be able to absorb the impact of inflation without much loss.
This largely depends on how essential the company’s products are.
Companies selling non-essential items, won’t be able to raise their prices without destroying demand.
For example, if a restaurant starts raising its prices, its would-be patrons may decide to eat at home instead.
Not to mention inflation tends to be followed by higher interest rates as we are seeing.
As lending becomes more attractive, more investors will pull their money out of stocks and into lending products such as bonds which causes a general reduction in stock prices.
So which stocks perform the best during periods of high inflation?
Stocks related to essentials like commodities.
That said, if you’ve invested heavily in commodities, you have to time getting out exactly right. This is because generally speaking commodities like Oil trend lower with time not higher.
Inflationary environments are when commodities tend to shine, then they pretty much stink the rest of the time.
Small cap or large? Growth or Value?
According to a recent Wells Fargo Report, during inflationary times “Small stocks top large ones. And S&P 500 growth stocks outperform value. This is a bit counterintuitive as energy sector stocks are typically included in value indexes and ETFs. And yet S&P 500 value stocks rose just 8% during inflationary periods. That’s nearly half the 12% gain by growth stocks.”
“And if growth is good, small stocks are even better. U.S. small-cap stocks rose 15% during inflationary times since 2000.”
Regardless of anything, whether you’re considering value or growth stocks, you want to make sure the companies you invest in have enough cash.
When inflation rises, interest rates follow and credit tightens. Consequently, companies that need to raise money either won’t be able to find it or will have to pay top dollar for it which will eat into their profits substantially.
3. Real Estate
Real Estate tends to do better in inflationary environments than stocks and cash. House prices and rent rates tend to rise with inflation, although rising interest rates can put a damper on how much houses rise since the more expensive it becomes to borrow, the less willing and able buyers there will be in the market.
“According to a 43-year review of the NCREIF Property Index, private real estate total returns were robust during years of inflation. A recent example is the 12 months ending in Q3 2021, when annual real GDP growth and inflation rates were 4.9% and 5.4%, respectively, but the NCREIF Property Index posted a healthy annual rate of 12.1%.”
The challenge with investing in Real Estate as a Muslim is finding a truly halal source of financing. Without financing, investing in real estate is much less practical. Even if you are able to invest, without any financing, your returns are going to be much more modest.
Gold investors often view it as a way to hedge against inflation risk.
The truth is, based on historical data, Gold’s returns have had very little connection to inflation.
“For example, gold investors lost 10% on average from 1980 to 1984, when the annual inflation rate was about 6.5%, according to Arnott’s analysis. The Federal Reserve tries to keep inflation around 2% per year. Similarly, Gold yielded a negative 7.6% return from 1988 to 1991, a period when inflation was about 4.6%. However, investors won big from 1973 to 1979, when the annual inflation rate averaged 8.8%. Gold returned a whopping 35%.”
To summarize, if you think Gold will necessarily protect you against inflation, historical data suggests sometimes it will, other times it won’t.
That said, Gold can be a great source of diversification since its price tends to have a mind of its own.
5. Bitcoin and cryptocurrencies
Since Bitcoin (BTC) emerged in 2009, it has greatly outperformed all other asset classes. From 2011 to 2021, the average annual return was 230%. This is ten times higher than the NASDAQ 100, the second-best performing asset class of the decade.
In terms of protecting against inflation, even though proponents claim that it does, we can’t say it fills this role yet. In fact, so far Bitcoin has performed like a high-risk technology stock. This makes sense since it is an emerging technology that largely attracts technology investors.
That said, if you think Bitcoin has a good long-term investment thesis, as I do, and you have a long-term investment horizon, then buying when the Bitcoin’s price dips seem like a prudent idea.
The same applies to any other cryptocurrency project you may be considering. Just know that if Bitcoin as an investment seems to have the risk profile of a high-risk technology stock, any other altcoin should be viewed as a ultra-high-risk technology stock.