Afraid of Inflation? This is How to Protect Your Wealth

When goods become more expensive, traditional saving becomes less attractive. If you stash away 100,000 Swiss francs in a safe in a period over which inflation rates average 2 percent, over just five years you will lose 9400 francs of purchasing power – nearly 10 percent of your wealth.

Savers and investors who expect inflation to grow will look for ways to preserve their wealth. The primary means of doing this is by investing in tangible assets. The reasoning behind that is that material assets have a real, physical value, which should not be affected by inflation. In many cases, the reality is more complicated. In this guide, you will learn which investment vehicles you generally can or cannot count on to hedge against inflation.

Stocks

Stocks are tangible assets with which you can – to a certain degree – protect your wealth from rising living costs. In the past 30 years, Swiss stocks increased in value by an average of 8 percent per year, after accounting for inflation. The annual inflation rate over that time frame averaged a relatively low 1 percent. But even between 1960 and 1990, a period over which inflation averaged nearly 4 percent per annum, Swiss stocks still yielded a return of around 3 percent after deducting inflation rates.

But whether or not holding your wealth in stocks protects against inflation depends on which kinds of companies you invest in. Historically, companies in so-called cyclical sectors performed well during times of high inflation when compared to the rest of the market. These sectors include the semi-conductor and automobile industries. Non-cyclical industries like the grocery retail sector, on the other hand, have delivered poorer performance.

Aside from the industry sector, it is also important to look at how well individual companies deal with inflation. Companies which have strong market presence and low investment requirements normally weather inflation better than companies which do not have those attributes. So the stocks of established companies generally feel the heat less than those of newer companies.

Before you hedge against inflation using stocks, it is important that you understand the risks involved. The values of stocks are prone to massive fluctuations, so you should only hold wealth in stocks if you will not need it for living expenses and unexpected costs or purchases. If not, you risk being forced to sell your stocks at a time when their value is low – possibly making a loss. Diversification is another important consideration when investing in stocks. By investing in a broad portfolio of different kinds of companies, you spread the risks associated with individual companies or sectors performing poorly. Exchange traded funds (ETFs) provide a simple way to diversify because by buying the stock of one ETF, you are investing in all the companies which the fund holds shares in. You can find useful tips for investing in stocks here.

For retirement assets too (pillar 3a), holding substantial stock investments is key if you want to hedge your retirement savings against inflation.

Precious metals

Precious metals, and primarily gold, have long been a go-to vehicle for protecting wealth from inflation. As tangible assets, precious metals typically gain in value when currencies lose in value. At least that has been the case in the past. Over the past 50 years, gains in the value of gold have not only matched inflation, but have delivered a considerable return.

ETFs and index funds make it easy to invest in precious metals without having to purchase actual physical commodities. For Swiss investors who prefer to hold physical precious metals, gold is a particularly interesting option because in Switzerland, gold is not subject to value added tax.

There is no reliable correlation between the inflation rate and the gold price. The value of gold goes up the most during periods of negative real interest rates – when inflation rates are higher than the interest rates of savings accounts. In every case, gold has historically been a proven hedge against hyperinflation – massive cost increases and currency devaluations.

In the case of mild inflation, stocks have proven to be a better investment. On the flip side, precious metals are considered a lower-risk investment than stocks and bonds, in spite of their price volatility. But unlike securities, commodities do not yield ongoing interest or dividends. If you are considering investing in gold, refer to the tips in the guide to precious metal investments.

Commodities

Precious metals are just one of many commodities which can be used to protect wealth from inflation. While storing commodities in your cellar may be possible in some cases, it is much simpler and more convenient to invest using instruments which track commodity price indexes.

Commodities indexes respond to inflation in a similar way to the price of gold. One reason for this is that the yellow metal is disproportionately represented in these indexes. For example, the gold price makes up about 15 percent of the Bloomberg Commodities Index, making it the strongest-weighted commodity underlying the index.

Another commodity upon which most commodities indexes are highly reliant is crude oil. Historically, the price of petroleum has kept up with inflation. The Bloomberg index includes two different petroleum-based commodities, which together represent nearly a third of the total commodities underlying the index.

However, the trend towards climate-neutral energy production has led analysts to predict that the roll of crude oil as a hedge against inflation will likely decline over the long term. Metals, on the other hand, are expected to continue to serve as a ballast against rising costs.

Real estate

Real estate is sometimes referred to as concrete gold, because it believed to offer a similar level of protection against inflation. When prices go up, the cost of real estate will normally also go up over the long term.

If you have a fixed-rate mortgage, you also benefit from inflation in that you continue to pay the same fixed interest even when the actual value of that interest declines. It is worth noting though, that the mortgage interest rates offered by banks generally account for their inflation predictions.

If you rent out your property, you will generally be able to raise the rent in keeping with inflation. In this case, the cost of inflation is passed on to the renter. If you live in your Swiss property, you are at a disadvantage because the imputed rent used for tax purposes will increase to match inflation. This may result in your paying higher taxes.

Regardless of inflation, the value of real estate is heavily dependent on regional market demand. It is possible for real estate to lose value, with the location and the type of property being key factors in the equation. You can find out what you should pay attention to when buying invstment properties in this guide.

Investors with relatively little net worth are well advised to abstain from investing in individual properties. The cost of obtaining and maintaining real estate is simply too high for many private investors. If you can only afford a single property, and have to invest the bulk of your assets into that property, you would be taking on a significant risk by concentrating all of your assets into just one investment. Real estate funds are typically a more suitable vehicle for private investors because they allow you to invest just a small part of your assets in real estate while benefiting from diversified investment in many different properties.

Alternative assets

Exotic tangible assets like art, rare whiskies, jewelry, diamonds, watches, wine, antiques, and classic cars are sometimes heralded as safeguards against inflation. Whether or not these alternative investments really do protect wealth from currency devaluations is difficult to assess. These are material assets, and it can be expected that their increase in periods of high inflation. But unlike conventional investments, there are no comprehensive price indexes for these assets. Because of this, there is no way to track the influence of inflation on their performance as investment vehicles.

Financial experts generally recommend that you only invest in exotic assets which you already have a strong interest in. Ideally, you should already be familiar with the market for the goods in question, and understand what their actual value is and the direction the market is going.

It is also important to understand that the markets for these assets are typically much smaller than those for other investment vehicles, so liquifying your assets takes more time and effort. If you ever need money in a hurry, holding assets which could take months, or years to find a buyer for may leave you in a tight spot. In the worst case, you may be forced to sell your assets far below their real value for lack of time. That could result in a loss, even if you manage to be inflation. Putting all your money into a Picasso or a watch collection is – regardless of inflation rates – a very risky investment, and is not recommended.  

Cryptocurrencies

Theoretically, cryptocurrencies should provide the ideal hedge against inflation. They are independent from central banks and generally have a cap on the amounts which can be created – features which should allow them to keep their value even when central bank currencies plummet. Many analysts believe that bitcoin will eventually serve a similar function to gold when it comes to hedging against inflation.

Many market observers agree that price changes of bitcoin have primarily been fueled by speculative interests. The price is directly linked to demand, so the number of investors willing to buy and hold bitcoin or other cryptocurrencies at any time directly impacts the value. It is too early to understand the impact of inflation on cryptocurrencies and their usefulness as a hedge against it. Unlike gold and other precious metals, the historical data for blockchain-based currencies does not yet exist.

Because the price of bitcoin is very volatile, it is even possible for a spike in inflation to trigger a plunge in the prices of cryptocurrencies. If price hikes resulted in an economic recession, this may cause big investors to shy away from risky alternative assets. Barring a stabilization of cryptocurrency prices, this scenario could possibly drive their value down.

Another key factor is that from a technological point of view, cryptocurrencies are software solutions which can quickly be made redundant by new, competing solutions. For example, a more powerful or useful blockchain-based solution could theoretically displace bitcoin very quickly. Because of this hypothetical expiry date attached to individual cryptocurrencies, diversifying your cryptocurrency assets to some degree is recommended. You can find more information about buying bitcoin in Switzerland here.

Bonds

Conventional bonds are not an ideal hedge against inflation. Because standard bonds have fixed interest rates, the yield you earn remains the same, even if its value becomes greatly diminished by inflation. You lose out in terms of real interest when the currency denominating a bond loses value.

The same applies to the bond principal which you get back at the end of the bond term. Assuming the borrower is capable of repaying the debt, you get back the same amount of money which you lent by buying the bond, with no compensation for inflation over the term. This means bond investments are vulnerable to inflation.

But there are also inflation-protected bonds. The principal and interest rates of these bonds are linked to inflation indexes. These provide an alternative to conventional bonds which safeguards investors from inflation.

However, the Swiss confederation does not offer any inflation-protected government bonds. Another consideration is that inflation-protected bonds generally have lower interest rates than regular bonds, so you pay for the inflation hedging by earning lower yields. For this reason, it only makes sense to invest in them if you expect inflation rates to climb over the bond term.

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