How to protect against inflation?

How can you protect yourself against inflation now that concerns about rising inflation and declining purchasing power are increasing? After all, the industrial states have become deeply indebted. To avert the crisis, central banks printed massive amounts of money and pumped the market full of liquidity.

Can stocks protect against inflation?

When inflation is high, shares are a good choice. Companies with a high degree of long-term finance are in particular demand. These include telecoms, utilities, consumer non-cyclicals, commodities and real estate, as well as the technology and healthcare sectors. A high dividend yield and solid and reliable business operations are also essential. The above at least applies to a scenario with inflation rates of around five percent. At an even higher level of inflation, companies will suffer greatly from the sharp decline in prices that they can no longer pass on to their customers. The result: profits fall and with them share prices.

Gold as protection against declining purchasing power

In times of inflation, precious metals enjoy great interest. Because investors fear a decline in the value of paper money, they resort to crisis-resistant currencies. After all, gold cannot be created at will to reduce its value. That is the difference between paper currency and payment obligations based on it, especially in bonds. With a fourfold increase in price, gold has been one of the best-returning investments in the past ten years. Expressed in euros, the gold price reaches a new record almost every day. Optimists also expect an increase in the coming years. They point to gold’s undisputed status as a “safe haven”. From a market perspective, the bull market is driven by stagnant to declining supply while demand increases. A crucial point in this context is the change of position of the central banks: from sellers to buyers. In particular, increased purchases by investors are stimulating demand.

Inflation, inflation expectations and real estate

The real estate market is not really picking up yet, although interest rates are historically low and prices are favorable. But times will also improve for homeowners and investors after a long period of doom and gloom, with inflation expectations also playing a major role . Real estate investments will demonstrably increase in value after a few dramatic years. This applies to Europe as well as to the United States, the Asian region and of course the emerging countries. As usual, the real estate sector is living up to its reputation of benefiting from the recovery with a delay compared to other sectors. The reason for this is also that lending by banks for such projects now appears to be getting underway again. The decline in rental prices also appears to have largely stopped. However, investors should not blindly invest in real estate just because they fear declining purchasing power . A property with a poor state of maintenance is never a suitable investment.

Government bonds

Longer term securities are not the best choice in times of inflation. Because when the general interest rate level rises, investors with long-term securities in their portfolio usually incur large losses on their bond holdings. Short-term bonds are then a better choice because owners can reinvest their money more quickly. Short-term and inflation-resistant loans offer a lower coupon rate than regular bonds. But that is why the coupons and repayment amounts are regularly adjusted to inflation. With inflation-linked bonds, investors therefore ensure a real return. But because these special bonds are in such demand, real yields are currently extremely low. Investors should wait before purchasing government bonds. Because if, for example, it appears that central banks will increase the base interest rate, yields on government bonds will rise, regardless of whether they are inflation-indexed or not. Investors who do not want to take risks with regard to the repayment of their capital are best advised to opt for home-grown government bonds. There is only one problem: the returns have fallen sharply as a result of the run on those securities and are as low as never before for all maturities. If government bond prices fall again and yields rise again, investors should, in case of doubt, wait out their price losses until the maturity date of the securities.

Corporate bonds

Corporate bonds have been very popular for the past six months. The problem is that investors who still buy them now earn little. Prices have now risen so much that euro-denominated corporate bonds with sufficient creditworthiness yield an average return of only 2.9 percent. According to index figures from the Bank of America-Merrill Lynch, this has never been low since the introduction of the euro. Yet corporate bond yields have not fallen as sharply as some government bonds. After all, they saw risk premiums rise by 1.05 to 1.2 percentage points in just 2 weeks in May 2010.

Inflation certificates

Investors who invest in fixed-income securities may be interested in securities whose interest payments increase with rising inflation, such as inflation certificates . Characteristic of most of these securities is that they guarantee a fixed coupon for the first interest payment that is higher than the current market interest rate. From the second maturity year onwards, the underlying base value used to measure inflation is either multiplied or added by a factor Inflation certificates are often supplemented with a capital guarantee . In a deflationary scenario, negative returns are usually excluded. The underlying value for a number of certificates is the price index for consumer goods, for others the HICP index ex Tobacco calculated by the European Statistical Office Eurostat (i.e. excluding tobacco products). But there are also certificates that use the Euribor as the underlying value. The decisive factors when purchasing inflation certificates are mainly the index, the creditworthiness of the issuing institution and the value by which the basic value is multiplied when interest is paid. Depending on the type of certificate and inflation developments, annual returns can be achieved with certificates that not only compensate for inflation, but also offer opportunities for significant additional returns. The risk? If price increases in the euro area remain moderate over the next five years, the certificates offer no advantages over traditional bonds. On the contrary, the high distribution surcharges of up to two percent make up a lot of the minimum guaranteed return, which is usually only guaranteed in the first year. Inflation certificates are therefore not suitable for short- and medium-term oriented investors.

Inflation in historical perspective

From 1914 to 2000, the general price level rose by about 150%, indicating a massive reduction in purchasing power. But our prosperity has increased fivefold in 85 years despite 150% inflation. Some economists even argue that inflation has fueled this increase in prosperity because it is often accompanied by significant economic activity. In that context, read Inflation in historical perspective.

Inflation in the Netherlands

At 2.6% in July 2011, inflation in our country was higher for the first time in 2 years than the average inflation rate in the other countries of the euro zone. The increased inflation in our country was mainly a result of:

  • the high fuel prices;
  • increased rents;
  • more expensive holiday trips.

In the rest of the eurozone, inflation averaged only 2.5 percent in July 2011.