What the heck does this phrase mean? I WAG it refers to putting your money into an investment which will grow faster than the rate of inflation?
- Jinx
Pretty much. It means that your portfolio as a whole should be invested in instruments that will outpace inflation.
It is important to note that inflation has a huge effect on wealth over the long run. $300,000 sounds like a lot now, but in 15-20 years, it will only buy $150,000 worth of stuff.
A lot of conservative investors have money in say, a whole life insurance policy (or savings account) that earns 3-4% a year. This money isn’t “growing” - it’s purchasing power will be identical to what it is today.
Pretty much. It means that your portfolio as a whole should be invested in instruments that will outpace inflation.
It is important to note that inflation has a huge effect on wealth over the long run. $300,000 sounds like a lot now, but in 15-20 years, it will only buy $150,000 worth of stuff.
A lot of conservative investors have money in say, a whole life insurance policy (or savings account) that earns 3-4% a year. This money isn’t “growing” - it’s purchasing power will be identical to what it is today.
Not to say that you shouldn’t have some of your money in a savings account, but you need to take some risks to get ahead.
Hedging is basically a technique to protect yourself against unforseen circumstances. For instance, if you are going to borrow at a fixed rate, but loan out at a floating rate, you would hedge by doing the opposite. This would protect you if inflation rises because you would not just be borrowing at the fixed rate.
What you’re missing here is the true definition of “hedge.” It’s a protective barrier. If you plant big shrubs in a way that they form a protective barrier, then that is called a “hedge.”
Q. Hedge against inflation?
I’m not sure that’s the full story. This just means your investment is making real return. This is good, but you can still be going backwards overall.
Hedging against inflation also includes balancing the risk of the currency depreciation (which can drive up inflation itself as the price of imported goods rise).
The classic “hedge against inflation” is gold (though less so since the gold standard was abandoned). Yet if you look at the price of gold it’s currently low and in all probability held artificially low.
In times of high inflation having some assets in gold (or silver, platinum, US notes etc) is strategically smart because they “hold their value” due to there being global demand for them. Their price does not need to keep pace increase in line with inflation and rarely does. But you can always find a buyer.
You may well have assets growing in value faster than inflation in your domestic economy but if the currency is weak all you can buy (simplistically) are more assets in the same currency. If you like, you’re up the front of the bus, but your bus is being passed by other buses.
I think an inflation hedge might be thought of as a protection against accelerating inflation. For example, under stable macroeconomic conditions, equity is typically the best investment. If the economy dips into a recession, a government bond tends to appreciate in value as interest rates drop. (So think of these bonds as a “recession-hedge”).
If inflation rises year after year, the corresponding rise in nominal interest rates depresses equity returns and pummels bonds. So although equity is expected to have a postive inflation-adjusted rate of return, it may not perform as well when inflation is rising.
Inflation-protected bonds make a decent (though not perfect) inflation hedge, since they they are guarenteed to pay the inflation rate, plus something extra.