What is Inflation?
Inflation is the rate at which your money loses value. When you have positive inflation, the same goods and services costs more in subsequent years due to falling purchasing power. The inflation rate is dictated by the interest rates set by the central bank of the country.
Why Address Inflation?
Every investor needs to address the issue of inflation when dealing with returns. If your investment returns do not beat inflation, then, the investment has actually lost value over the time. A little bit of inflation is desirable by the government since it keeps the money moving and the economy growing. The inflation rates for United States and Canada are shown in the charts (source: inflation.eu).
As you can see from the chart, we are currently at extremely low levels of inflation, historically speaking. Another way to look at this is that we also have the potential of higher inflation in the future.
How to Fight Inflation?
There are a few investments that are good at combating inflation, simply due to their nature. The best inflation hedges are:
- Inflation Indexed Bonds: These are bonds that are tied to a country's inflation index. They go by different names in different countries. In Canada, they are called Real Return Bond and in the United States they called Treasury Inflation Protected Securities, or TIPS for short.
- Commodities: Commodities are generally a good hedge for inflation protection.
- Gold is considered one of the best inflation hedges.
- Oil can also be a good hedge against inflation.
- Food products - food prices are one of the quickest responses that companies can manipulate in case of higher inflation.
- Everyday consumer staple items such as toothpaste, razors etc.
- Real Estate: This could be either in the form of your personal home value or owning REITs to get real estate exposure.
My Portfolio Holdings
- I do not own any Inflation-Indexed bonds.
- Commodities exposure:
- Gold: I own IAMGold (TSE: IMG, NYSE: IAG), a gold mining company instead of owning gold bullion.
- Oil: I own Chevron (CVX) and Kinder Morgan Inc (KMI) instead of holding/trading oil futures contracts.
- Food related: I own agriculture/farming related companies/organizations such as Archer Daniels Midland (ADM) and CHS Inc (CHSCP).
- I own REITs which can quickly raise their rent in case of high inflation. I own Realty Income Corp (O), RioCan REIT (REI.UN) and Omega Healthcare Investors Inc (OHI).
Full Disclosure: Long all stocks mentioned above.