How To Prepare for Inflation
In modern-day America, in the 2020s, many investors and speculators are concerned that the country is diving head first into a hyperinflationary period. They often draw parallels between today’s economy and the 1970s, during the great inflation period. While people sometimes blamed the pain of inflation on currency speculators and oil prices, much like today, the true cause was likely the Keynesian monetary policy.
The government of 1970s America ran a deficit to shield from the early blows dealt by the 1960s, and by the 1970s, the stock market had crashed, and real pain had set in. Inflation peaked at over 11% in 1974 and over 13% in 1980. Interest rates had to be set at nearly 20%, driving an increase in unemployment rates to around 9% and almost 11% in 1975 and 1982, respectively. Eventually, the recessionary period and other factors stabilized inflation and unemployment, but the recession had already done the damage, and many people had been burned.
Warren Buffett’s Model For Choosing Inflation Favoring Businesses
Warren Buffett, a legendary investor, and billionaire, still recommends buying stocks during times of high inflation. However, he does not necessarily recommend market indices. Instead, he prefers to buy a business that can do two things: Increase Prices for Consumers and Scale Up Operations Easily.
Ability To Increase Prices Easily
Being able to increase prices easily means that the company can charge more for their product or service without sacrificing many customers. Usually, to achieve this, they must not deal in raw materials and commodities and must offer something unique. They must also have quite a wide moat, making it difficult or impossible for their competitors to steal their customers away at lower prices.
Ability To Scale Up Quickly And Cheaply
For a company to be able to scale up quickly and cheaply, it must have a low marginal cost of production for its product or service. Take Facebook as an example. If the times called for it, Facebook could push 50% more ads to users and collect the extra money from advertisers. This would come at practically no additional cost to the company and take very little, if any, to accomplish.
Take On debt
This one may be somewhat controversial because many have become mortified by the idea of debt. Consumer debt, especially with high-interest rates like credit card debt, is something to be scared of and avoid. You want to ensure you pay your credit card balance every month before the balance is rolled into debt. However, we’re talking about fixed-rate loans like fixed-rate mortgages. This could also work when the money is invested in a tangible resource like gold or valuable companies, but for simplicity, let’s consider real estate.
A 5% fixed rate mortgage, when inflation is at 10%, is a profitable loan before considering any investment. This may not sound right because the 5% compounding interest costs a lot to pay, right? However, inflation is deducting from the value of the dollars you’ll owe in the future at a compounding rate of 10%. This means while you owe 5% more dollars each year on the loan, each dollar you owe is worth 10% less each year. This practically means you’d get a 5% real return simply by borrowing the money, which would help preserve some cash.
However, when in combination with the asset class it’s being used to buy, the true nature of debt reveals itself. Debt is an opportunity to spend somebody else’s money today, with a promise to pay it back over time. If money is more valuable today than you expect it to be throughout the loan, it’s a good idea to take out the loan. About our previous example of 10% inflation and 5% mortgage interest, let’s assume your real estate appreciates at approximately 6% per year. This would give you a 1% real return, and that’s before considering planting crops or renting to tenants for extra cash flow.
Buy Real Estate
In the long term, not many other assets come close to the reliable returns of real estate. While inflation does affect different kinds of real estate differently, land and retail real estate are poised to outperform in times of high inflation. Since there will not be more land made, and savvy investors can use the land for virtually anything and everything, it’s a no-brainer investment for many millionaires and billionaires. Many of the world’s richest people have been swooping up land for the past few decades, perhaps in preparation for sky-high inflation.
However, it’s not like this is an investment that will not produce a return in normal times, as oftentimes they do. Rental properties, for instance, can be a great cash flow-producing model for your real estate portfolio that will perform very well in all environments.
Buying Gold Bullion
While Gold Bullion hasn’t been shown to outperform other investments when shock inflation hits, the short-term price action is where its weakness ends. In times of persistent high inflation, especially hyperinflation, Gold Bullion performs very well. In addition to this, it does disgustingly well during times of deflation. In fact, this may be a very attractive option to investors who feel like either deflation or inflation could be coming up shortly.
Buy I Bonds
Distributed by banks and pegged to the inflation rate, I bonds can give you exposure to a moderate return, maintaining a large percentage of your purchasing power through a period of high inflation. The biggest drawback to these bonds is that there is a limit on how many you can buy per year, usually $10,000 worth. However, some senators are trying to increase those limits for risk-averse investors, so it’s worth looking into it to see if they’ve made any changes.
Buying Cryptocurrency (Bitcoin)
In 2021, many people saw Bitcoin as a martyr for inflation. They saw it as a truly safe place in a market otherwise caught in the rain. Unfortunately, it hasn’t panned out that way in the months since. However, it’s still early for Bitcoin, and especially for cryptocurrency as a whole. It would be obnoxious to write off the asset class, but at the same time, it is highly speculative, and it’s unknown how it will perform during persistent hyperinflation. A couple of months of high single-digit CPI increase isn’t exactly what I’d call hyperinflation, meaning Bitcoin, sometimes called digital gold, could respond exactly as gold does in times like this. Time will only tell how aptly described ‘Digital Gold’ is.
Buying Seeds
Speaking of buying farmland, seeds, and other food-related items can be a small yet great addition to a balanced plan. These can provide nourishment in a true worst-case scenario and become valuable if food becomes scarce. In this article, we’re not going to take a deep dive into prepper territory, but if you think a ‘worst-case scenario is imminent, you may want to. After all, in the ‘worst case,’ money, stocks, and gold all become meaningless. Food, water, shelter, etc., become the only things worth having, and if you want to exist in a world like that, you may want to plan for it. However, it’s also probably not worth sacrificing happiness and fulfillment if humanity continues to thrive just for you to live somewhat longer in the depressing doomsday scenario that will probably never come up. Think about it…
Limit Your Consumption
A frequently overlooked method of changing your situation during inflationary times is to limit your consumption. Set spending limits and stick with them. If you can’t stay stable standing up, then squat down. This means turning off lights and devices when you’re not using them and keeping the thermostat a couple of degrees warmer in the summer and cooler in the winter. Energy bills are one of the most important places ordinary people can and should save money during inflationary periods.
Invest In Your Own Skills And Abilities
Possibly the most important and most potent one on the list, invest in you! Put time, effort, and money into something you can repeatedly do to make more money. Develop that craft, and get better with it. Eventually, you’ll be able to sell your services to someone else or build something profitable, such as a YouTube Channel or a sneaker flipping business. This would also include going to school. However, unless you’re getting a highly technical and specialized degree for something like Law, Medicine, or Engineering, it’s probably not a great idea to invest a large amount of money into a degree. Be honest with yourself, are you actually going to pursue the career as a full-time day job for 10+ years after graduating? If so, hop right in. If not? Perhaps there are better ways you could invest in your education. Parents paying for school? Get the degree. Remember that unless you directly use the degree to get a job that pays for the degree, any debt associated with it is categorically ‘bad debt.’
Conclusion
While these steps are sure to help you maintain your wealth during a financial downturn, especially when accompanied by elevated levels of inflation, many of the steps are best practices that can help you build up your wealth regardless of where in the cycle you start.
Also, many people will probably claim that some or all of these strategies are ‘dice rolls’ or ‘gambles’ based on how specific prices shake out in relation to each other. This would be more true for an investor who buys a US market index than for one who buys individual properties and securities, as much less is understood about how the US will fare compared to the world than could ever be known about a particular business or equity.
Put, inflation itself is the gradual devaluation of one currency. If not for assets that grow in value over time, the only option for your savings account would be to hold the value as cash. This would mean that everybody was susceptible to inflation the same, which we know isn’t true.
In an unfortunate case of irony, the poor are often too scared to borrow money, unable to understand the relationships between cash, value, inflation, and taxes enough to know that high inflation is a good indicator that it’s a good time to invest. In other words, sell off your cash for something more valuable!