High inflation can lead to a substantial erosion of your local currency’s purchasing power. Even low levels of inflation can have a significant effect on the real value of your overall wealth over the long term. With that in mind, it is important for you to find suitable investment options, especially if you wish to maintain or even enhance the value of your savings/investments.
Are you concerned about the effects of rising inflation on your investments? Have you been looking for a way to protect your investment/savings from the negative effects of inflation? Are you thinking about investing in gold as a solution to all these problems?
If your answer to all of the above questions is to the affirmative, you have come to the right place. In this article you will be able to learn useful information regarding:
- What is inflation?
- The effects of inflation on your savings
- Why is gold considered to be a good hedge against inflation?
- Why is gold not the perfect hedge against inflation?
- How to invest in gold to safeguard your savings against inflation
At the end of it all, you should be able to have a clear idea of whether gold is a good investment when inflation is high.
To ensure that you end up making a well informed decision at the end of it all, this article includes links to various studies supporting the information included here.
What Is Inflation And Why Should You Invest In Inflation Proof Assets?
The purchasing power of your dollar declines overtime due to the gradual increases in the average prices of goods and services. This phenomenon can be described using a situation where a dollar is unable to go as far today, as it did yesterday.
When thinking about inflation, it is important to note that it is not simply an increase in the price of a single product, but an increase in the average prices of products in an entire market sector, and ultimately the economy as a whole.
Inflation is normally measured using the Consumer Price Index (CPI), the Producer Price Index (PPI) as well as the Personal Consumption Expenditures Price Index (PCE). The CPI is calculated using the cost of consumer goods that urban consumers normally buy out of pocket. On the other hand, PCE is calculated using the things that people pay for as well as those that they do not pay for including things like healthcare which is covered through government benefit programs or insurance.
Since the Federal Reserve uses PCE to make its monetary decisions, this inflation measure is considered to be superior to the other available measures.
The Main Causes Of Inflation
Prince increases that are considered as inflation can be caused by a number of causes including:
- Increased Demand (Demand Pull Inflation)
In the simplest of terms, this type of inflation comes about when overall demand increases, while supply remains the same; thus resulting in a market scenario where demand is seemingly pulling prices upwards.
This normally happens in a healthy economy – in which businesses are making more money, passing it on to consumers in the form of higher wages, for instance. Consumers in turn buy more stuff thanks to their increased buying power. As companies attempt to up their production to meet the growing demand, prices for existing goods increase as competition to buy them also increases.
- Higher Costs (Cost-Push Inflation)
Cost-Push Inflation on the other hand occurs when the supply of goods declines due to one reason or the other, while demand remains the same. This leads to a situation where prices for the limited supply of goods rise as supply is outstripped by demand. A great example of this is when the production of a certain products is hindered or interrupted by the occurrence of a natural disaster.
Inflation may be good or bad. When properly managed, a little inflation can be beneficial to the economy. This is because an increase in prices from year to year gives producers the space they need to adjust their production costs and pricing to reflect changing economic conditions. However, when prices increase by a huge margin in short periods of time the resulting inflation (commonly referred to as hyperinflation) can have huge negative implications on the stability of the economy.
While short-term inflation may not seem to have a huge impact, in the long-run, inflation can significantly affect the value of your savings, and overall wealth. As such, understanding inflation can help you safeguard the value of your money.
One of the best ways for you to safeguard the value of your money/savings in the face of growing inflation is to invest in inflation-proof assets. Generally, to keep your savings or investments from losing value, inflation-proof assets must be able to earn a return that is equal to or greater than the average inflation rate of the US (estimated to be averaging about 3.7 percent – since 1960).
With that in mind, it is worth mentioning at this point that gold is seen as one of the best assets to invest in when it comes to protecting the value of your savings during times of high inflation.
Simply put, investing in gold can help you counter the negative impact of inflation on the value of your savings [1].
Why Is Gold A Good Hedge Against Inflation?
Over the years, gold has been seen as a good hedge against inflation. In fact, many people from various cultures across the globe use gold to pass on wealth from one generation to the next. This is mainly due to the fact that the precious metal has been proven to hold its value well as time passes, even in the face of inflation.
How is this possible? Well, like other real assets such as property and silver- whose supply is limited – the price of gold actually rises in tandem with the rising prices during inflationary periods. This negative relationship with the value of the local currency has the effect of maintaining the value of the precious metal.
To further explain this relationship you should think of gold as any other commodity, priced in the local currency. As fiat-money loses value, and the average prices of goods start rising, so does the price of gold; thus, increasing its value.
This precious metal is also a good hedge against a falling economy because as interests rates decrease, gold prices normally go up.
As a result, the metal is considered to be a good hedge against inflation.
It is worth noting that while the change in price might not match the exact change in inflation, especially with gold prices fluctuating from time to time, in the long run, the real inflation adjusted value of gold is preserved.
Why Is Gold Not A Perfect Hedge Against Inflation?
While gold is considered to be a great store of value, and a good hedge against inflation by many, it is not seen as a perfect hedge against inflation in some quarters (Source: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2078535).
One of the main reasons behind this belief is the fact that gold does not have any earning power.
In general, gold is seen as a 1:1 hedge against inflation. This simply means that the rate of change of its value is similar to the rate of change of inflation. Any investment whose value changes as a multiple of inflation is considered to be a better hedge against inflation than gold.
It is also worth mentioning the fact that some people don’t consider gold to be an investment simply because it does not offer the owner any earnings.
If you can find an asset that is capable of appreciating in value or providing a return that is a multiple of the rate of inflation, you will be able to earn a handsome return in addition to protecting the value of your investment during inflationary periods.
How To Safeguard Your Savings/Wealth With Gold
As you can see from the above, gold can be purchased as a means of protecting the value of one’s wealth during inflationary economic periods.
To ensure that gold provides you with the best level of protection against inflation, various studies have shown that you should pick the right time to invest in the precious metal; and, then hold it for an appropriate amount of time.
According to research findings, you should invest in gold about 18 months before inflation reaches its highest point. Afterwards, you hold the precious metal as part of your investment portfolio for around 18 more months, at the very least. This approach guarantees the best possible outcome.
Holding gold for a shorter period, such as a month, is not recommended. This period is too short to provide any worthwhile protection against inflation, and its negative effect on the value of the local currency, and ultimately, your wealth. Furthermore, the price of gold tends to be highly volatile in the short term. However, it always seems to even out over a longer period.
As an investor looking to preserve the value of their wealth, including gold as part of your investments, especially in periods of high inflation can go a long way towards helping you preserve the value of your wealth. As a rule of thumb, it is best to keep your gold investment at between 10 and 20 percent of the overall value of your investments. This ensures that you enjoy the protection provided by gold, while still enjoying the returns provided by other securities.
In such cases, gold is actually gives you a means of further diversifying your portfolio. Gold has the effect of dampening the volatility of a typical investment portfolio, given its low correlation with other asset classes.
Conclusion
Inflation can significantly affect the value of your savings/wealth. Considered to be a debasement of fiat currencies, inflation may mean that your dollar won’t go as far tomorrow as it did today. As an investor, you can be able to safeguard your wealth against the negative effects of inflation by investing in inflation-proof assets.
Gold is considered by many to be a great hedge against inflation. The precious metal is known for holding its value well; and, has been used for many years as a transfer of wealth from generation to generation.
While it is not a perfect hedge against inflation, research shows that investing in gold, at the right time, and holding it for a reasonable amount of time afterwards can help you preserve the value of your wealth during periods of high inflation.
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