Want to hedge against inflation?
Today I was going through the book the intelligent investor by Benjamin Graham.It is widely regarded as the bible of the stock market.What is written on it about inflation and its effects on various asset classes is very interesting.Analysis based on past history of inflation is done and what should we expect in future is given.
Firstly What is inflation?
Inflation is the term used to describe the decrease in purchase power of a currency.We can get goods and service today at a cheaper rate than we can get a year later that is, it is increasing in inflation.Similarly, the opposite is known as deflation.
To protect ourself against inflation in future, we require taking a step now.
Stocks Against Inflation
It is widely regarded that stocks are good to protect ourselves against inflation.That is true most of the times but not always.To get the actual picture past historical analysis is done in the book the intelligent investor.If you look in the above graph which is displaying the relationship between inflation and stock prices between 1926 to 2002 we get a clear picture.
On the extreme left of the graph, we can see that the stock prices fell when the inflation was negative that is when there was deflation.Stocks stank up to 43% during deflation.On the extreme right, we can see that too much inflation that is above 6% is also not very good.The stocks market lost money in 8 of the 14 occasions when the inflation was more than 6%.Only mild inflation is good for the stocks to perform.
Historical data suggests that the stocks were able to keep up with the inflation in 78% of the times but not all the time.But that is quite impressive for us to purchase stocks to hedge against inflation.
Gold:A Hedge against Inflation
Many people believe that the best hedge inflation is a precious commodity like gold.But this is not the case.Gold prices fluctuate in a random manner.At times it can give returns less than the interests that we get from the savings bank.But at other times it can give return almost 100% in a short span of time.So the prices of gold vary widely and cannot be considered as the best hedge against inflation.
Real estate:A Hedge against Inflation
Real estate can be considered as a very good means of the hedge against inflation.While you can go for purchasing real estates yourself there are other better options available to get in the real estate.Real Estate Investment trust(REITS) are a company which owns and collect rents from commercial and residential properties.There are mutual funds available in America such as Vanguard REIT Index fund which bundles together the REITS and diversifies it.
Best Instruments to Hedge Against Inflation:TIPS(America) or IIB(India)
The best Instrument to hedge against the inflation is Treasury Protected Securities(TIPS) which were first issued in America in 1997.In India, we have the similar type of bonds available to us known as the Inflation Indexed Bonds(IIB) issued by the Reserve Bank of India.Reserve bank of India first issued such a bond in 2013.These bonds will automatically go up when the Inflation rises.As these bonds are issued by Treasury in America and RBI there is no chance of default(or nonpayment of the interest).They ensure that your investment will not be eroded by inflation.By going for this you can insure yourself against financial loss and the loss of purchasing power.