Inflation occurs when the prices of goods and services in an economy rise over a period of time. Using a price index like the CPI (Consumer Price Index) or the PPI (Producers Price Index), inflation is measured by calculating the percentage change from one year to the next.
Normal inflation is between 2.3 percent and 3.3 percent. Inflation below 2.3 percent is considered low, while inflation between 3.3 percent and 4.9 percent is extremely high. If inflation soars to over 4.9 percent, it's classified as being extremely high.
What impacts inflation?
Low and steady inflation is ideal since it’s a sign of a good economy. Factors that help drive a healthy inflation rate are solid production, high consumer spending, and high employment rates and wages. The U.S. Federal Reserve aims for an average annual inflation rate of about 2 percent.
However, due to factors outside of any economy’s control, inflation can remain extremely low or skyrocket. It hasn't been determined yet how the COVID-19 pandemic will impact long-term inflation. Eviction and foreclosure moratoriums, massive relief packages, and record-high unemployment claims haven't shown how they will impact the U.S. economy.
However, investors can hedge their bets and protect their portfolios if a period of high inflation occurs. Being ready to jump on an investment that's better suited for such times can help safeguard investors' wealth.
Gold is a hedge against inflation.
For decades, gold has been relied upon as a hedge against inflation. As a real and physical asset, gold tends to hold its value. Countries that have seen their currencies lose value have used gold as a sort of alternative currency.
Gold isn't the perfect cushion against inflation. When inflation rises, interest rates tend to increase as part of the overall monetary policy. Holding onto gold, which doesn't pay yields, might not be as valuable as holding onto other assets that pay yields.
Commodities are an option.
Commodities are an overarching category of real materials and agriculture products. Seemingly ordinary, everyday goods, commodities can shield investors from high inflation. Many commodities like water, grain, and natural gas will always be in high demand regardless of economic environments.
The relationship between commodities and inflation is somewhat correlated. When inflation rises, so does the price of commodities.
The good news for investors is that it’s pretty easy to gain exposure to a diversity of commodities assets via ETFs or buy stocks in companies that deal directly with commodities.
Real estate income
The real estate market has raised quite a few eyebrows and frustrated many people looking to buy homes during the COVID-19 pandemic. With record-low interest rates and record-low inventory, securing real estate has been tricky.
For those who can add rental properties to their portfolio, investors can ensure that they can keep up with rising inflation.
As inflation increases, so do home values and rent prices. Homes purchased with fixed-rate mortgages can keep payment costs low while reaping the benefits of rising rents and appreciating home values.
TIPS are indexed to inflation.
TIPS (Treasury inflation-protected securities) are a type of U.S. Treasury Bond. TIPS are indexed to inflation to protect investors from inflation. TIPS payout semiannually on a fixed rate. The principal value of TIPS changes based on inflation. Therefore, the rate of return includes the adjusted principal. Investors can choose between three maturities rates—five-year, 10-year, and 30-year.