Friday, May 07
Investing Long Term? Don't Overlook Inflation

Investing Long Term? Don't Overlook Inflation

We have all heard the old adage, “Money doesn’t grow on trees.” Perhaps it would in the perfect world, but as it stands, one of the certified means to grow money is through investments.

Investment has been established as a key factor in the accumulation of wealth which will help in the achievement of financial freedom in the years ahead.

When investing for long-term goals, it is important to consider the effects of inflation on your investment returns. Over time, inflation can erode the value of an investment as a moderate inflation rate today can have a large impact on the purchasing power of your money over 20 or 30 years.

This is especially true in today’s COVID-impacted environment where around the globe, governments launched stimulus packages over unprecedented amounts in the wake of the pandemic, causing a dramatic increase in public debt.

This has raised the question of how the high volumes of debt can ever be repaid in the future. Through economic growth? Budget surpluses? Or will the debt be inflated away? Experts have purported that it is not certain that the coronavirus crisis will lead to higher inflation in the long term. Nevertheless, it may be worthwhile for investors to take a detailed look at the potential implications of rising inflation.

One may ask; what is inflation? Inflation is defined as the increase in prices of goods and services, usually occurring over the course of a year. It is generally associated with a loss of the purchasing power of money: After a year, people can buy fewer goods for the same amount of money in visual terms.

A poor harvest increases food prices– as there are fewer goods available for money to chase. However, in addition to supply and demand changes, other factors may be responsible for rising inflation, such as government borrowing and a subsequent money supply expansion facilitated by the central bank, which then devalues the money held in physical cash or bank deposits.

A nation's monetary authority such as a Central Bank, will work to keep the rate of inflation within a margin that keeps the economy running and encourages growth. Some level of inflation is necessary as it promotes spending which helps national economic growth. In most countries, the Statistical Office publishes the inflation rate every month 

The opposite of inflation is deflation, which represents a sustained decline in the level of prices for goods and services. Here, the main risk is that both consumers and companies would have an incentive to put aside their increasingly valuable money and postpone purchases and investments over and over again. This would trigger an economic downward spiral.

Risks associated with inflation

Inflation reduces the purchasing power of money: For example, if an employee always receives the same salary for a period of time, he or she can afford less and less because of rising prices.

Inflation is one reason many people don't put all their money in the bank. As one saves and invests, it is paramount to keep an eye on inflation trends. If inflation rises, savings and assets shrink in real terms. Capital invested at a lower rate of return than the inflation rate steadily loses purchasing power. For this reason, investors need to make sure that the interest rate or yield on their investments is above the inflation rate.

Inflation Affects Savings

Inflation has a negative impact on savings and shrinks them with time. For instance, if you have ₵100 in your savings account that pays an interest rate of 1%, you will have ₵101 at the end of the year. However, if the inflation rate is more than the interest rate, at say 2%, you will require ₵102 to have the same buying power as at the beginning of the year. Thus, you will effectively lose money if your savings do not grow at the same rate as inflation.

This situation has become even more critical in the current times with record-low interest rates. At the current rate of interest paid to the savers, the money saved and interest earned will not be enough to balance the loss in value of money caused by inflation.

How Inflation Impacts Investments

The impact of inflation on investments depend on the investment types. For investments with a set annual return, like regular bonds or bank certificates of deposit, inflation can hurt performance, since you earn the same interest payment each year, it can cut into your earnings. If you receive a payment of ₵100 per year, for instance, that payment would be worth less and less each year given inflation.

For stocks, inflation can have a mixed impact. Inflation is typically high when the economy is strong. Companies may be selling more, which could help their share price. However, companies will also pay more for wages and raw materials, which hurts their value. Whether inflation will help or upset a stock can depend on the performance of the company behind it.

On the other hand, precious metals like gold historically do well when inflation is high. As the value of the dollar goes down, it costs more dollars to buy the same amount of gold.

Finally, there are some investments that are indexed for inflation risk. They earn more when inflation goes up and less when inflation goes down, so your total earnings are more stable. Some bonds and annuities offer this feature for an additional cost.

 Protecting yourself against inflation

As established above, over time, that inflation can erode the value of those savings. For that reason, some prefer to keep some of their money in potentially higher-growth investments like stocks or mutual funds, because on average these investments earn more per year than the inflation rate 

Investors can reduce their exposure to inflation risk using a variety of methods. The most popular method to hedge against inflation is by purchasing hard assets, including gold, oil, farmland, natural gas or, to a higher degree, real estate. In general, these assets tend to be negatively correlated with both stocks and bonds.

Real assets can usually provide protection against inflation. These include Commodities like gold, Real Estate and Equities.  

In addition, investors could take advantage of inflation-indexed bonds, in which the nominal value and/or the coupon are linked to consumer price trends. If inflation rises, for example, the coupon payment due on these securities increases accordingly.

Real Estate

Owning your home is perceived as a value in this situation because residential real estate prices tend to move in the same direction as inflation.

It is a popular choice not only because rising prices increase the resale value of the property over time, but because real estate can also be used to generate rental income. Just as the value of the property rises with inflation, the amount tenants pay in rent can increase over time.

These increases let the owner generate income through an investment property and helps them keep pace with the general rise in prices across the economy.

Commodities

When a currency is having problems— as it does when inflation climbs and decreases its buying power— investors turn to commodities.

For centuries, the leading commodity has been gold— and, to a lesser extent, other precious metals. Gold has been considered a store of value by mankind for thousands of years, which is one of the reasons why it was minted into coins in earlier times.

Investors tend to go for the gold during inflationary times, causing its price to rise on global markets.

Gold can also be purchased directly or indirectly. You can put a box of bullion or coins under your bed if you favour a direct purchase, or you can invest in the stock of a company involved in the gold mining business. You can also opt to invest in a mutual fund or exchange traded fund (ETF) that specializes in gold.

Commodities also include items like oil, cotton, soybeans, and orange juice. Like gold, the price of oil moves with inflation. This cost increase flows through to the price of gasoline and then to the price of every consumer good transported by or produced. Agricultural produce and raw materials are affected as well as automobiles. Since, as it stands, society cannot function without fuel to move vehicles, oil has a strong appeal to investors when prices are rising.

Equities

Equities are real assets as well. They represent ownership interests in a company, which in turn owns other real assets– and shareholders therefore own a small part of these assets. These could be administrative buildings or machinery, for instance. Thus, it is quite common to see share prices rise on the equity markets when inflation rates pick up.

Loans/Debt Obligations

Leveraged loans are potential inflation hedges as well. They are a floating-rate instrument, meaning the banks or other lenders can raise the interest rate charged so that the return on investment (ROI) keeps pace with inflation.

Mortgage-backed securities (MBS) and collateralized debt obligations (CDOs), which are structured pools of mortgages and consumer loans respectively, are also an option. Investors do not own the debts themselves but invest in securities whose underlying assets are the loans.

Setting financial goals, following through Discipline

Setting financial goals is often a smart choice and can be very rewarding when reached or attained. When one sets a financial goal, one is able to define what he or she wants and develops a plan for achieving it. Instead of wandering purposelessly, one would have something to strive for and a clear path for getting there.

The set goals need to be SMART: Specific, Measurable, Attainable, Realistic and Time bound. Some financial goals one might set as an individual includes saving for a comfortable retirement, saving to send your children to the university, or managing your finances to enable a home purchase.

Financial goal setting is important to realizing the big vision one has for life. The dreams and desires one has is usually only achievable, if one has the financial discipline to make it happen. And having that capacity means creating a roadmap of how one will get there, hence, the importance of goals setting.

Some few steps one can take now to help reach his or her financial goals and become wealthy include

Realize your core values

Reaching one’s financial goals starts with one’s core values.  In order to find true financial success, one must do well in all areas of life and determine what it is that he or she believes in and stands for. Core values underpin and guide our decision making and behaviours and decisions made in life are often based on our values.

One’s values therefore lies at the very core of everything one is as a human being. The virtues and qualities one stands for, constitutes the person one has become and continue growing into. All improvement in one’s life including financial improvement begins with one clarifying his or her true values, committing oneself to living consistently with them and aligning everything one does with them.

When one aligns his or her work and personal life to support his or her financial goals, one will find it much easier to reach them or any goals set.

Align goals with values

Aligning one’s goals with his or her values helps one to become a living magnet. This means his or her thoughts create a force field of energy that radiates out from him or her and attracts back into his or her life, the people and circumstances that are in harmony with those thoughts.

Most people that have achieved financial independence and become wealthy had the idea of wealth and success in their mind long and hard enough which drew into their lives the resources needed to ensure their success. The main objective therefore is to keep one’s mind fixed on improving his or her personal finances and achieving financial independence.

 Assign a Priority to Each Goal

One probably must have a long list of goals, and it would be nearly impossible to tackle them all at once. To start, one must choose the short- and long-term goals that are most important now and focus on them.

Prioritizing all of one’s goals helps to direct the right amount of money to each of them, including the one that seems so out of reach.

If one is saving to send the kids to the university without any debt, and his or her unfeasible goal is paying off a home, one might be surprised by the idea of placing a lower priority on the university. Between the two, one’s contributions will be the only way his or her home will be paid off sooner than its 15-, 20-, or 30-year note. Kids can take out student loans. Although not ideal, they will have another option -- you don't!

Consider each of the goals carefully to determine which options are available have for each. Tackle the biggest ones first. The unattainable goal might not have the highest priority, but chances are one can rearrange his or her current budget to direct money there. But don’t give up on goals that don’t make the priority list. After one has achieved some of the prioritized goals, he or she may be able to get started on them.

 Think big but start small

Also when it comes to setting financial goals, one must think big but start small from wherever he or she is. High achievers always set challenging goals and continue to work towards them in everything they do. Self-made millionaires all started with a dream and one of their secrets is dreaming big.

To reach one’s financial goals, one can practice back from the future thinking. This involves imagining the kind of life one wants to be living in the future. For instance, imagine that five years have passed and life is now perfect in every respect. What does it look like? What are you doing? Where are you working? How much money are you earning? How much do you have in the bank? What kind of a lifestyle do you have?

One then makes a list of the logical steps, in the order that will get from where he or she is now, to where he or she wants to be. Subsequently, figure out what big or small action you can take today to propel you.

 Accept that financial goals are long term strategies

Many people fail to realize that financial goals are for the long term. They instead go through their days and their money trusting they would get lucky and somehow become wealthy.

People buy lottery tickets, gamble and think about enjoying quick and huge profits in the stock market. The fact, however, is that financial success is a long term money so one should give himself or herself time to plan it out.

Those with financial freedom are patient, persistent and far sighted. They discipline themselves to save and accumulate money over many years. As a result of this habit, their wealth grows annually and they usually surpass their financial goals sooner than expected and keep going.

 Commit Now to Living beneath Your Means for the Rest of Your Life

Living beneath one’s means will provide most of the spare cash one will need in order to accomplish his or her goals. Learning to live beneath one’s means is one of the central costs of learning how to become financially independent.

This involves probably having to cut out every expense in one’s budget that is not absolutely necessary, and even do what one can to reduce those that are.

It could include passing of the annual family vacation, driving a car for years after paying off a car loan and buying clothing in second-hand stores while everyone else you know shops at the mall.

That's just a short list of the sacrifices one will have to make. But in making them, one will be clearing money in his or her budget to build savings, to get out of debt, and to invest for the future.

 Always Save Money no Matter Your Income

Don't be one of those people who says "I'll start saving money when..." The problem with telling yourself that is "when" never comes.

One should always save money despite what is happening. That's one of the very best strategies to make sure one is always moving forward.

If one doesn’t have enough room in his or her budget to save money now, then the answer is to increase one’s income, lower his or her expenses, or both. One should also keep himself or herself accountable by reviewing his or her budget monthly. This keeps you on track to reaching financial goals.

Just writing down the goals will help one start the process. Also, reviewing them regularly and having honest conversations about where one is financially will determine one’s success or failure in reaching his or her financial goals.

Stay Out of Debt

It's difficult to attain financial goals when one owes money to banks or other people. One important goal one should set is getting out of debt as soon as possible.

Create a timeline for getting out of debt because there is no overnight solution to the current debt problems.  The timeline however points one in the right direction.

Once you get out of debt in any category, stay out and make sure to never come back. There is no such thing as "good debt" when one is trying to reach his or her financial goals.

 Expect the best

When setting financial goals, expect the best. The law of expectations says that whatever one expects with confidence, whether positive or negative, becomes the reality.

Don't worry about failure as it breeds negativity. If you confidently expect to become wealthy, hold on to that belief and act like your financial success is inevitable. One will eventually achieve that goal.

Successful people who become rich expect to succeed in advance. The wonderful truth about expectations is that, they are completely under your control. You decide for yourself if you want to become rich and how you're going to get there. The more you think about financial independence, the more you base your decisions on time and money.

Reaching financial goals isn't easy hence a detailed plan is needed as well as a commitment to stick to it. This list serves as a guide, and can be modified to fit anyone’s circumstances. Attaining your financial goals is possible, as long as you don't give up.

Is the Prudent Man wiser than the Prudent Investor?

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COVID-19 has the Potential to Change the Investment Landscape forever

COVID-19 has the Potential to Change the Investment Landscape forever

No one in their wildest dream perceived the year would turn out relatively nightmarish ‘overnight’. While some are still hoping to be nudged out of the bad dream, others are in ‘rehab’ trying to detoxify their system from COVID-19 news and updates. Yet still, others are nursing their nimble minds by maintaining some level of positivity and mental agility as economies are being sucked in the pandemic quicksand. For most countries, they are still being sheltered in their homes with restrictions still in effect as some governments and analysts are bantering over flattening the curve analysis and containment tactics.

As stock market values for big companies have dropped rather significantly, no one would ever perceive being involved in any kind of investments right now, and the few who might be considering the prospects are hedging their bets by taking cautious steps. For all intents and purposes, as to the bright scenarios of investing in anything right now, almost every sector has had a huge capital chunk bitten out of financial activities with productivity a mere mirage. Correspondingly, it might seem an unlikely phenomenon and highly improbable at large as some experts are of the view that preceding economic meltdown such as the financial crisis of 2008 and the great depression are still fresh in the minds of investors even though the relatively levelheaded and patient ones were able to cash in later when the economy improved. Investopedia corroborated the assertion by saying, “instead of acting rationally during severe bear markets many people tend to overreact and make matters worse. However, while many people panicked or were forced to sell assets at low prices, a small group of patient, methodical investors saw the stock market collapse as an opportunity.

“Investors of behavioral finance shows that people, rather than being merely risk-averse, are actually more loss-averse. This means that people feel the emotional pain of a loss much more than the pleasure gained from an equal-sized profit. Not only that, but loss-aversion describes peoples' tendency to sell winners too early and to hold on to losses for too long; when people are in the black, they act risk-averse, yet when they're in the red they become risk-seeking”.

Quite understandably, there is palpable anxiety and reasonably so amongst throngs of people who are burdened with what the future holds for them and their families. These fears have been legitimized by the International Labour Organization (ILO) which indicates that at the start of the year, 190 million workers were unemployed around the world and that the disruption to the world’s economies caused by the Covid-19 pandemic is expected to wipe out 6.7% of working hours globally in the second quarter of this year which is an equivalent of 195 million jobs worldwide, and that four fifths of workers globally live in countries affected by full or partial lockdown measures. The report also indicates that the four sectors which will be hardest hit globally includes accommodation and food services, manufacturing, retail and business services as well as administrative activities. Also, “workers in the informal sector who account for 61% of the global workforce risk job loss. It revealed that, two billion people have jobs in the informal economy, representing the most vulnerable workers in the labour market and will need income support just to survive and feed their families if their jobs disappear”. Albeit they did not explicitly project the exact number of workers who might be rendered jobless, it intimated that it’s likely to spike much higher than 25 million projected in the month of March.

With all cards clearly stacked against any investment odds as most individuals are resorting to “piggybank saving” and trying to save and frugally spend on a long rain pandemic day, companies are meticulously renegotiating at every turn in an effort to recoup what is left of their businesses, making any form of investment implausible now. Some stock markets analysts believe that the COVID-19 pandemic has the potential to change the investment landscape forever. In a euronews interview, the cofounder of Market Trader Academy, Amro Zakaria Abdu, said,

“It is going to accentuate the difference between the financial world and the economy, they should be linked, but they're not. I think it's also going to accentuate the difference between the rich and the poor, unfortunately, just because all this stimulus money is going to the capital markets and not everyone owns a capital like stocks and bonds”.

Despite recent commodity and financial markets decline which has sent some investors through the rotating door, she strongly advised private clients and financial institutions saying there’s more money to be made, even in time of volatile trade, citing the increase in demand for Zoom platform. “There’s a new category called a ‘stay-at-home stocks’. Things like Zoom, for example, has gone up by 106% since the beginning of the year. Microsoft, Amazon just hit a record high and Alibaba is the same thing.”

Investment opportunities in the pandemic

It might seem a long shot but there is always a precedent to problems and with solutions proffered not occurring in a vacuum space, analysts have reasons predicated on their assertions that investing in a time of crisis is actually the opportune moment to strike gold. Investopedia is of the view that, “while most investors are panicking as asset prices plummet, those with a cool head are able to see the resulting low prices as a buying opportunity. Buying assets from those restless individuals driven by fear is like buying them on sale. Often, fear drives asset prices well below their fundamental or intrinsic values, rewarding patient investors who allow prices to revert to their expected levels. Profiting from investing in a crisis requires discipline, patience, and, of course, enough wealth in liquid assets available to make opportunistic purchases”.

In such calamitous state, most people are driven to act rather irrationally by selling their stocks and bowing out, simply to cut back losses. But what they also fail to understand is that, like every other crisis, things will begin to look up and only the brave at heart can genuinely smile to the bank and not have a hindsight situation of “what-could-have-been”. “After the Japanese attack on Pearl Harbor, the S & P 500 index fell more than 4% and continued to drop another 14% over the next few months. After that, and through the end of the war in 1945, however, the stock market returned more than 25% per year on average. The same pattern can be observed after other geopolitical events. By recognizing the fact that markets tend to overreact, a smart investor can purchase stocks and other assets at bargain prices.

“Stock markets aren't the only way to invest in a crisis. The great recession also saw a collapse in home prices as the housing market bubble burst. People who could no longer afford their mortgages foreclosed and many homes were underwater, the mortgage amount owed to the bank exceeding the equity value of the property. Homebuyers and those investing in real estate were able to pick up valuable real assets at below normal prices, and as a result have been able to enjoy handsome returns as the housing market has stabilized and recovered. Similarly, so-called vulture investors have also been able to profit from taking over good companies that have been battered by a recession but have otherwise good fundamentals”.

Stocks aren’t the only go-to when it comes to places to invest and although a few eyebrows might be raised on the other places to invest, real estate is quite the ‘diamond in the rough’ especially in seasons of recessions. According to realwealthnetwork, “Recession, home values decline in certain markets, mortgage interest rates are usually low, and there’s steady rental demand but with very little competition from other investors/buyers.  Like gold and silver, real estate is a physical asset. And buying when the market dips to take advantage of low prices and interest rates can be a really smart investment during a recession. If you currently own one or more properties, they may have lost some value. But that doesn’t mean you won’t ever get that money back–like the stock market. Real estate markets and values will come back up as the economy recovers and it’s one of the best long-term investments, even during a recession”.

Corroborating the ideology of Investopedia, the Entrepreneur suggests that,

“though a major recession can bring serious losses to many industries, real estate— provided wise investments are made— is usually not among them. Recession usually leads to a drop in home values, meaning that you may be able to buy a property at a lower price and sell it for a large profit when prices rise back up after the economy and markets have recovered. In the meantime, you can rent the property out to a tenant, generating reliable passive income during the interim period”.

Recessions really separates the men from the boys as it tests them on the anvil of challenges and risky situations, and truth is recessions with this current pandemic included never really create a new normal especially for investors who have gone through the fire of such phenomenon. Drinking deep or not at all will remain merely a try-out for those who are still sitting on the fence while the strong at heart bells the recession “cat”.

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