With the US Government keeping interest rates at the lowest possible level while printing money like there is no tomorrow (QE3 coming up anyone?), all we can fear is to see climbing inflation rates to come. In addition to this, the prices of commodities are rising and if you live in Canada, it’s not any better as the Bank of Canada resists raising interest rates based on economic uncertainty and a already strong dollar. However, this hasn’t stopped inflation from rising in the meantime…
So you probably want to protect your portfolio against inflation. How can you do it? Gold? Real Estate? Think again! I’ll debunk these 2 investing myths by stating that gold and real estate offer the best protection against inflation.
Gold Vs Inflation
Okay, repeat after me: gold is not the best hedge against inflation. Yeah, right, you are going to tell me to go back and look at the charts since 2008 and look at the awesome return of gold (+81%). However, the recent rise for gold is based mostly on speculation with investors trying to recover from their 2008 losses by speculating on the yellow metal.
If you go back in time, I mean, really back in time, you will notice that the price of gold has only followed inflation. In fact, an ounce of gold back in the Egyptian times (which is more than 2,000 years ago) represented the cost of a nice outfit for a ceremony. Today, the price of 1 ounce of gold (roughly $1,550) is about the price for a very nice Hugo Boss suit or ball gown. Therefore, in 2000 years, we hasn’t been much change. Plus gold is subject to high volatility. Sometimes you are lucky and it’s on the upside, but if you are not that lucky, you could eat your socks for a while!
Real Estate Vs Inflation
All right, if gold is not the best hedge, we’ll invest in real estate (especially if you can pick a few great Canadian REITS 😉 ). However, here again, real estate won’t be your biggest ally to fight inflation. The overall return over a long period of time on real estate investing is usually around 5%. Since we should have inflation between 2 and 3%, we should be fine. However, there are other ways to protect your investments from inflation…
Bonds Vs Inflation
Regular bonds are pretty bad against inflation. Why? Because where there is inflation, there will be rising interest rates to follow. Remember, interest rate increase = drop in bond value. Considering the interest rates payable on bonds at the moment, I guess it’s not the time to buy them if you want to hedge yourself against inflation. However, you can take a look at TIPS, which are government bonds hedged against inflation (interest rates will increase according to the rate of inflation). The interest rate will still be pretty low at the moment but if you don’t want to see fluctuations in the value of your portfolio, this is the “safest” type of bonds on the market.
Dividend Investing Vs Inflation
One of the reasons why I like dividend investing so much is because it provides an immediate protection against inflation through the dividend yield. You can currently build a solid dividend portfolio paying you a 3%+ dividend yield. This should be enough for your investment to grow “inflation free” while you enjoy growth from:
– Future dividend growth (when companies continue to increase its dividend over time)
– Capital gains (these companies are still generating profits and their stock may rise)
Stocks Vs Inflation
When you go back to the basics, you will notice that the stock market is the best weapon against inflation. Why? Here’s the logic: when inflation rises, it is usually based on a strong economy. When people make more money, they buy more stuff. Which leads to increased production, to people making more and more money and buying more and more stuff. This is how inflation is created. Therefore, if people are making more money and they are buying more stuff, chances are that company earnings will grow as well, right? And if company earnings grow, don’t you think that their stocks will follow?
Historically, the stock market has always risen an average of 8 to 9%. Inflation over the past 20 years is around 2%. This sounds pretty easy to beat with the stock market!
However, in my own portfolio, I will keep accumulating dividend stocks. I really like getting so much in dividends deposited in my account on a steady basis. It makes market slumps a lot more smoother ;-).
I’m 100% stocks right now, and I’m pretty close to fully invested, so I would say I agree with you. I think there is room for real estate and a small allocation to bonds in the future for myself, but for now I’m all-stock all-day. I’m still young (29), so I have time to diversify this over time as I definitely believe in diversification across asset sectors. Per your list, I probably won’t be buying gold at any time. Thanks for the article!
Isn’t *any* rise in Gold purely speculation?
Fantastic article! Very few people realize gold is a great inflation hedge, and that is all!!! Gold should only be bought when it is really low, and then as a hedge and/or diversification strategy.
Like all investments, valuation matters and asset allocation diversification is wise investing. Even if we agree that dividend stocks are the best inflation hedge and the best valuation for investing today; no one should be 100% or near 100% in any asset. This is dangerous behavior!
Regardless of age, if you lose 50% of your portfolio it takes a 100% gain to breakeven. If you only lose 10% of your portfolio, it only takes an 11% gain to breakeven. Stock valuations are high right now and a portion of one’s portfolio should be in cash now.
I am currently holding a 43% cash position in the Arbor Asset Allocation Model Portfolio (AAAMP). The AAAMP has out performed the S&P500 with only a fraction of the volatility because of our risk adverse strategy.(http://arborinvestmentplanner.com/philosophy.php )
Buy Dividend Growth Stocks but keep cash for buying stocks at better valuations!
Sure, gold is not *the* hedge against inflation. But it is *a* hedge, or rather, a consistent store of value.
Good article. Assets that have their prices based on incoming cash flows (like stocks) are the primary way to beat inflation.
Excellent post, I think ill have to visit this blog more often. Quote from Jeremy Siegel:
“stocks are not good hedges against inflation in the short run—but then no financial asset is. In the long run, stocks are extremely good hedges against inflation, while bonds are not.
Inflation, although kinder to stocks than bonds, does have some downsides for equity holders. Fear that the Fed will tighten credit if inflation threatens causes traders to avoid stocks, at least in the short run. Inflation also overstates corporate profits and increases the taxes firms have to pay. Furthermore, because the U.S. capital gains tax is not indexed, inflation causes investors to pay higher taxes than would exist in a noninflationary environment.”
I agree with you that gold is more of a store of wealth than an accumulator. But I would say that stocks and real estate when managed as a business are in fact pretty close when it comes to return after inflation. Real estate shows minimal capital gains, but has cash flow. Stocks split it about 50/50 with gains and cash (dividends).
Sir John Templeton said pretty much the same thing about stocks and inflation before he died. I would like to buy a second property as a rental. But, most of my money is parked in the stock market right now. Gold is for teeth and jewelry.
I’m not worried about inflation as much as stagflation.. I’m not convinced the great recession is over, despite what the experts declare. When you look at what’s happening as the government stimulus is removed (the GDP is lowered “unexpectedly”) I think it’s so much smoke and mirrors. Of course, this is in the US. but I’m not sure the global economy is much better off what with Greece dragging down the eurozone…
Stagnant wages, chronic high unemployment and rising commodity prices has me thinking stagflation.. Anyone else?