7 Inflation Hedging Strategies You Must Know!

Inflation erodes the value of money, so it's important to know how to hedge inflation. Find out how investing in the right portfolio of assets helps you hedge against inflation and protect your investments.

Introduction

To understand the 'hedge against inflation' meaning, you need to understand what the term inflation means. When there's a sustained rise in the price of goods and services over a period of time, the economy experiences inflation, leading to a fall in purchasing power.

Inflation is measured using CPI or the consumer price index. If the CPI is 7%, then ₦100 last year would be worth ₦93 this year.

To protect yourself against the effects of inflation, you need to diversify your portfolio with different asset classes. These include stocks, real estate, bonds, and stablecoins.

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What is Inflation?

In simple terms, inflation denotes reduced purchasing power over a period of time. What one Naira can buy you today is less than what it could buy you last year.

Inflation in Nigeria went up to 20.52% in August 2022. So if you bought an item for ₦100 last year, the same item would cost ₦120.52 this year.

The basket of products used for computing inflation includes cereals, food grains, healthcare, entertainment, and utilities. The overall increase of products included in this basket measures inflation.

We find the effects of inflation on your money next.

How Inflation Affects Your Money

Here are some ways in which inflation affects your money:

Lower Purchasing Power

When inflation rises, your purchasing power falls. For example, if your monthly expense was ₦40,000 last year and the rate of inflation is 7%, then your monthly expense today will be ₦42,800. Money tends to lose value, and you need to pay more to buy the same quantity of things.

Future Value of Financial Goals Higher

Inflationary forces also cause the cost of your financial goals to go up.

If long-term inflation is, say, 6%, and the cost of retirement today is around ₦10 million, then 30 years later, you would need approximately ₦47 million to retire comfortably.

If your savings fall, you would have to either try for a higher-paying job or do a second job to increase your savings.

Higher Prices

With high inflation, your monthly expenses become higher, and you need more money to pay for them. If you take a loan, then your EMIs go up as well.

In the next section, we show you how to hedge inflation through the right investments.

7 Ways to Hedge Against Inflation

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Here are 7 ways to hedge your savings against inflation:

1. Move Your Money into a High-Yield Savings Account

Just keeping your money in a basic savings account will not help you hedge against inflation. Part of your savings that you need to protect from stock market volatility, like your emergency fund, can be invested into a high-yield savings account.

2. Buy Treasury Bonds

Treasury bonds are also better options compared to savings accounts and are a safe investment option. These bonds are backed by the government with a maturity period of 1 year.

You won't get regular interest and can easily buy them through banks or brokers. Plus, treasury bills are taxable and can easily be converted into cash.

3. Invest in the Stock Market

A great strategy to hedge inflation is to invest in the stock market. Here are some viable options:

• Buy and Hold: The buy and hold strategy suggests holding on to your investment for at least 3 to 5 years. Depending on the performance of the stocks you have invested in, you could earn 100x your original investment. However, you need to be patient and avoid a panic sell-off due to market volatility in the short term.
• Value Investing: If you invest in a stock whose intrinsic value or book value is higher than the market value (market price of stock x total number of shares), you have a higher chance of making a profit. This is the basic principle of value investing.  Buying such stocks when the market corrects or falls helps you earn higher profits that hedge against inflation.
• Growth Investing: There are two types of growth investing, long-term and short-term. You can include stocks in your portfolio for the long term if you want to meet long-term financial goals like retirement. If you feel you can earn high profits in a year or two, then you can go for short-term growth investing. Both these strategies are a great inflation hedge.
• Income Investing: Your investment decision will depend on whether you're interested in income generation or wealth creation. Investing in a cash income-generating stock will not increase the value of your portfolio. You can earn cash income through either a dividend from stocks or fixed interest. These investment strategies are ideal for beating high inflation.
• Dividend Growth Investing: When you invest in a security that pays high dividends, you face less volatility compared to growth stocks. Such companies don't pay you the dividend and instead reinvest it in the stock. These stocks give you higher long-term returns with the benefits of compounding, that are the perfect hedge against inflation.
• Passive and Active Strategies: Passive investment strategies follow the buy-and-hold model. Since you don't buy and sell stocks in your portfolio frequently, you have lower transaction costs. If you want to earn more than an average investor, you need active investment strategies. Your portfolio keeps changing frequently since you are constantly booking profits from your stocks.
• Contrarian Investing: These investment strategies are based on valuation, and the goal is to buy low and sell high. As a contrarian investor, you constantly look for a stock with high future growth potential, high entry barriers (to prevent competitors from entering), and transparent management. You buy stocks with high intrinsic value compared to market price and invest when the prices are at their lowest point during a recession or calamity.
• Indexing: Instead of investing in stocks directly, you can invest through exchange-traded funds or ETFs. These are types of ETFs or mutual funds that invest in companies that are part of a financial market index. Some of the top index funds you can consider are the Stanbic IBTC ETF 30 and the NSE (Nigerian Stock Exchange). These funds have passive investment strategies and low expense ratios, making them cheaper than actively managed mutual funds.
• You can apply passive and active investment strategies for other asset classes as well. You can choose the respective index for the specific asset class and invest in them for passive investing. If you want higher returns, then choose individual mutual funds where active asset selection is made.

4. Diversify Your Portfolio

Diversifying your portfolio by investing in more than one asset class is important. By doing this, you protect yourself when the price of a single stock falls since the other stocks or asset classes can pull up your average returns to hedge against inflation. Here are some strategies for portfolio diversification:

• Domestic stocks: If you have sufficient knowledge of stocks, you can invest directly, or you could invest in domestic stocks through mutual funds. Investing through ETFs is less costly and risky since it is a passive investing strategy.
• International Stocks: There are mutual funds like the Stanbic IBTC Dollar Fund that lets you invest in US equity and fixed-income instruments. You can diversify your risk by investing in these funds and earning higher returns.
• Bonds: This investment is less volatile compared to stocks and provides the investor with regular interest income.
• Short-Term Investments: CDs (Certificate of Deposits) and money market funds are short-term investments that offer the security of capital. These are low-risk, low-return options.

5. Invest in Dollars

You can further diversify your investment portfolio apart from stocks and bonds through alternative investments like dollars. One of the best investment options you can access here is Nigeria’s best dollar-saving app, Pillow.

You can start by investing as little as ₦3000 and hedge against inflation with returns as high as 14% annually. More importantly, these investments are covered by a $250 million insurance policy.

6. Invest in Real Estate

Real estate also represents a good inflation hedge. You can invest in real estate through REIT (Real Estate Investment Trusts).

There are 3 different types of REITs, including equity REITs (investing in commercial properties), Mortgage REITs (investing in mortgages), and Hybrid REITs (investing in both Equity REITs and Mortage REITs).

With inflation, the rent of commercial properties goes up and acts as a hedge against inflation.

7. Invest in Gold and Precious Metals

These investments are also an example of good inflation. The price of gold goes up with inflation, making them the ideal hedge against inflation.

Let's find out next the best asset class to hedge against inflation.

Which Asset Class is Best to Hedge Against Inflation?

The best investing strategy to hedge inflation would depend on the time horizon of your financial goals. Here are the best asset classes to invest in for different time horizons:

Short-Term Investing

If your investment horizon is less than 3 years, it is considered short-term. The ideal investment strategies for this period would be CDs, money market mutual funds, and bonds.

The reason why these investments should be used as a hedge against inflation in the short term is that they are stable compared to stocks. Markets are volatile in the short term, and stock prices can fluctuate, leading to losses. Financial goals like emergency funds can be achieved through such products.

Long-Term Investing

Your best hedge against inflation for the long term is equity. The right stocks protect your portfolio from high inflation. You could also invest in stocks through equity mutual funds, both domestic and international. Other investing options for equity include ETFs.

The buy-and-hold investment strategy works best for equity investing in the long term. Investing through ETFs is a passive investing strategy where the fund tracks an index, and the investment portfolio remains stable over time.

When you invest in large-cap, mid-cap, or small-cap mutual funds, you take a higher risk and earn a higher return. Active investing has greater volatility compared to passive investing.

Here are some buy-and-hold strategies:

• Core and Satellite: The core portion of your investment portfolio would comprise a large-cap index fund with a passive investment strategy. The satellite portion consists of actively managed funds.
• Tactical Asset Allocation: You need to balance your investment portfolio in this strategy using 3 asset classes - stocks, bonds, and cash. Active investment strategies are required for tactical asset allocation, and depending on the market movement, you need to shift your investment from stocks to bonds or cash. Your asset allocation will depend on your financial goals and risk tolerance.

Conclusion

High inflation eats into your savings, and your monthly expenses go up. When your savings lose value, you need to earn more to save more. Investment strategies to hedge against inflation will differ from individual to individual since your needs and earning potential are unique.

Before you think about investment strategies, you need to assess your financial goals using the SMART (Specific, measurable, achievable, realistic, and timely) method. Make a list of your financial goals in order of priority, like retirement, higher education of children, or down payment for your home.

Estimate the present value of your financial goals and then use the long-term inflation rate to estimate future value. There are free online calculators that you can try or consult with a personal finance specialist. Prepare a budget to determine the best investment strategy for achieving your financial goals.

FAQs

Is Gold a Good Hedge Against Inflation?

Yes, gold is an excellent inflation hedge. The price of gold tends to go up with inflation since the supply of gold is limited, unlike paper currency which tends to lose value. Explore digital assets to hedge your valuables against inflation.

Why is Real Estate a Hedge Against Inflation?

Depending on the location of real estate, it is a hedge against inflation. With inflation, your property price goes up, and so does the rent you receive. Your net worth and income both rise to fight against inflation.

Which Type of Annuity Lets you Hedge Against Inflation?

Annuities that have an increasing income option that goes up with high inflation are the best hedge against inflation. However, most annuities in Nigeria offer fixed-income opportunities.

Is Bitcoin a Strong Hedge Against Inflation?

Since Bitcoin moves in the opposite direction compared to financial assets and is scarce, it should ideally provide a hedge against inflation. But past performance indicates otherwise - Bitcoin rose with high inflation for the period December 2020 to January 2021, but from January 8 to January 11, the value fell even though inflation was high and rising.

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