How to Beat Inflation – The Ultimate Guide

Inflation is a necessary evil that takes away our purchasing power but induces future growth. The current US inflation rates comparing 2020 to 2022 shows a four-fold increase in inflation to 8.5% by March 2022. Inflation is inconvenient if you hold liquid cash, pay home rent, have an adjustable mortgage, or buy consumer goods and services. It may give you a reason to consider securing a mortgage now or investing in inflation-hedged assets like gold, real estate, fixed-rate mortgages, TIPs, stock, and stable currencies to beat inflation. We need to consider the costs and benefits of inflation before making any investment decision. Here’s everything you need to know on how to avoid inflation.

What is inflation?

Inflation happens when the price of assets (goods and services) increases over a period of time. Let’s understand inflation through purchasing power. You could purchase eight eggs with $1 in 2010 but only four eggs with that same $1 in 2022. Though the nominal value of $1 remains constant, the amount of goods or services you can purchase with that $1 has now decreased. Inflation has decreased the purchasing power of the dollar during this period. It also pushes the price of fixed assets like real estate and stocks higher over the long term.

How is inflation measured?

Inflation is measured on a basket of goods and services to reflect the macro outlook of a particular sector. In the US, the Bureau of Labor Statistics (BLS) compiles the Consumer Price Index (CPI), which comprises thousands of goods and services like food, fuel, housing, medical care, apparel, transportation, entertainment, etc. that Americans buy every day. It is a weighted average, meaning that an increase in house prices will affect the index more than a similar increase in the price of eggs. Inflation is the percentage change in the CPI over a period of time.

How does inflation affect assets?

Inflation affects different asset classes differently. You will typically lose your purchasing power during inflation if you are invested in the following asset classes.

  • Savings
  • Fixed interest rates
  • Corporate/Treasury Bonds with yields lower than inflation
  • Consumer backed equity

Conversely, you can gain long-term income during inflation if you are invested in the following asset classes.

  • Real estate
  • Commodity/Real estate-backed equity
  • Adjustable interest rate deposits
  • Fixed mortgages
  • Gold
  • TIPS

Think of inflation as the process of decreasing the money supply from the system. Banks charge higher interest on loans and reduce deposit rates. This makes money dearer, and investors flock to buy safe assets with liquid cash, further driving up prices. For example, the value of a home and its mortgage rise simultaneously during inflation. While the owner pays a higher interest to the bank, he will charge a higher rent or quote a higher sale price to pass on the inflation costs to the end buyer. This process continues until there is no buyer for the peak rate/price.

How does inflation affect savings?

Inflation has a negative correlation with savings, meaning that you will lose the value of your savings during inflation. The difference between the deposit and inflation rates is the actual return on your savings. If you are getting an interest rate of 2% per annum and the inflation rate is 8%, you are losing 6% of your purchasing power annually. Even though you have the same nominal value of cash in your savings account, you will be able to purchase 6% fewer goods/services after one year.

How does inflation affect debts like loans?

The interest rates on loans rise during inflation. Usually, this is balanced by a similar increase in earnings. Working professionals can take additional credit at a higher rate because inflation leads to higher wages. Businessmen can take small business loans at higher interest to offset rising costs during inflation, which can be further charged from the end consumer.

However, inflation can add weight to your existing liabilities when there is no growth in earnings. Analysts believe that we may pay more taxes during inflation even when the IRS adjusts some tax brackets based on inflation. You can benefit by paying off your tax liabilities early at the start of inflation. Students with variable interest stude