While inflation is a normal part of a functioning economy, extreme inflationary conditions can affect businesses and individuals and can concern both new and experienced investors. Inflation risk is always present, and thoughtful investors can take steps to protect their assets through what is known as hedging against inflation.

This article introduces the basics of inflation, how it works, and how it is measured and managed within the United States economy. It will then explore common ways investors protect their portfolios for long term stability.

Contents

• What Is Inflation
• What Causes Inflation
• How Is Inflation Measured
• When Is Inflation Risky
• How to Hedge Against Inflation

What Is Inflation

Inflation is a general rise in prices over time. It does not refer to the price of any one good or service but rather an average of a broad set of prices within the economy. These measurements show how much people are paying for common goods and everyday necessities.

Because world economies are interconnected, prices tend to rise and fall together over time. This movement is inflation.

For example, in 1900 the average cost of an acre of farmland was 20 dollars. One hundred years later it was 1050 dollars. Over time, most goods and assets have increased in price even if not at the same rate.

What Causes Inflation

Many factors influence inflation, including supply and demand for goods, technological development, globalization, and monetary policy. Economists describe inflation through three main concepts:

• Demand pull inflation occurs when available money increases and demand rises faster than supply, causing prices to increase.
• Cost push inflation happens when production costs rise and businesses raise prices to keep up while demand stays stable.
• Built in inflation appears when people expect rising prices and demand higher wages to maintain purchasing power, resulting in a wage price spiral.

How Is Inflation Measured

The most common measure in the United States is the Consumer Price Index, or CPI, which tracks changes in the basic cost of living. It considers the prices of consumer goods such as food and household needs as well as common expenses like utility bills.

CPI percentages reflect the change in inflation over a twelve month period. The Producer Price Index, or PPI, measures inflation from the business perspective. It tracks the average change in selling prices for goods and services.

When Is Inflation Risky

The Federal Reserve aims for an inflation rate of about two percent over time since this level is generally linked with stable prices and strong employment. Inflation becomes risky when it grows faster than wages or other economic indicators. When purchasing power drops, people find that money no longer buys as much as before.

For investors, rising inflation reduces the future value of each dollar. An investment that once produced strong returns may produce negative real returns once adjusted for inflation. At the same time, consumers may have less extra income to invest.

Serious problems emerge when inflation grows uncontrollably, resulting in:

• Hyperinflation where inflation accelerates rapidly
• Stagflation where high inflation occurs alongside slow economic growth and high unemployment

How to Hedge Against Inflation

Hedging is simply protecting the value of your investments. Investors commonly use two main approaches:

• maintaining a diverse portfolio
• allocating to inflation resistant assets

A diversified portfolio spreads risk across different asset classes so that your overall financial health remains stable even when individual sectors fluctuate.

Assets to Buy to Resist Inflation

Many investors prepare for inflation by allocating a portion of their portfolios to assets that tend to hold value during inflationary periods. These include:

• Treasury Inflation Protected Securities
• stocks especially blue chip or preferred stock
• international investments
• real estate including farmland
• commodities
• precious metals
• funds tracking commodities or real estate
• floating rate bonds or bond funds

Final Thoughts

• Inflation occurs when the average price of goods and services rises over time.
• A healthy economy experiences gentle inflation, but rapid or extreme increases can erode the value of investments.
• Investors can build resilience by maintaining a diversified portfolio that includes assets known to resist inflation pressures.

Investors and savers should always be aware of inflation risks and take steps to protect their portfolios. Many investors are turning to land as a long term diversifier and a natural hedge against inflation.

Disclaimer
The content above is intended for general educational and informational purposes only. Historical performance does not guarantee future results. All investing involves risk including the possible loss of principal. Diversification does not guarantee a profit or protect against loss. Investors should consider their objectives risk tolerance tax situation and liquidity needs before investing. Investment options vary in fees risk factors and strategies. Some investments are speculative and may not be suitable for all investors.

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