The Impact of Inflation on Savings
If you keep your money in the bank or in money market funds, inflation can eat away at their value. Inflation can be deceiving because your account balances won’t go down. However, when you take your money out to buy something, you might notice that you won’t be able to buy as much as you used to. Therefore, if you don’t put your money into something that keeps up with inflation, you’ll soon find your savings won’t buy as much.
As an investor, you need to be prepared for the risk of inflation. It happens when there is too much money chasing too few goods, so prices have to go up (because of an increase in the money supply). When the economy is facing high inflation, it is very damaging to your savings and investment portfolio. However, not all investments do poorly when inflation is high. Gold tends to do well during periods of high inflation and can be a good investment hedge against inflation risk.
The Impact of Inflation on Investments
Inflation is also very damaging for fixed income investments like bonds. A bond pays out a certain interest return on your money each year. Inflation cuts into this annual return. Say a bond pays a 5% interest rate and inflation is 4%. This means the actual return on your bond is only 1%. If inflation really takes off, it is possible for bonds to earn a negative rate of return. Therefore, bonds are real problem investments during periods of high inflation.
When inflation is high, it drives up prices in the economy and reduces the profits of companies. Since inflation also makes your currency less valuable, the profits earned by companies will also be worth less overall. As a result, stock prices may rise or fall when inflation is high but they usually don’t keep up with inflation. See Inflation Adjusted Stock Prices
Inflation’s Impact on Gold
Since gold is a commodity it tends to rise in tandem with other commodities so, it doesn’t get hurt by inflation. In other words, as the value of paper dollars decreases the value of Gold, Silver, Food, and Oil, etc. all rise. And so precious metals tend to keep up with inflation over the long term. When people fear inflation, or mistrust governments or the financial markets, they tend to flock to gold thus boosting the price and helping it retain its value. Inflation Adjusted Gold Prices
Inflation’s Impact on the Economy
Inflation also can be very damaging to the economy. It adds a layer of uncertainty to monetary transactions. What will the currency be worth next month, next year or 10 years from now? This uncertainty causes businesses and individuals to take less risk and thus the overall economy grows at a slower rate than it would have without the uncertainty, often this results in a recession.
This is another advantage for gold as an investment. When the economy is doing badly and people are worried, they tend to invest more in stable assets like gold. This pushes up the market price of gold. If some of your portfolio is invested in gold, it can help offset the losses from your other investments and create an overall safer portfolio.
Investing your money is a never-ending battle against various financial risks. By investing some of your money in gold, you can make sure you that you are protected against the risk of inflation.
Guest Post contributed by Patrik Fonce. Patrik is a trader with more than 10 years of experience trading financial markets. He is also a writer and works currently at QuantShare Trading Software.
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photo credit: Bullion Vault