Rethinking investment strategies in times of inflation

Recent high inflation has rattled investors, forcing them to reassess traditional investment strategies. Cash, once seen as a safe store of value, is rapidly losing its real value. This begs the question: in an age of inflation, is cash still king?

This article looks at the challenges inflation poses to cash holdings and explores alternative investment strategies that can help investors through a difficult period.

Restricting cash: erosion effect on inflation

Inflation refers to a steady increase in the overall price level of goods and services in the economy over time. When inflation rises, the same amount of cash buys less. For example, if inflation is 5%, your €100 today will only be worth €95 next year.

This decline in purchasing power is having a negative impact on cash holdings. Investors who hold a significant proportion of their portfolio in cash may lose out on potential growth opportunities and have difficulty maintaining their standard of living.

Measures and impact of inflation 

The concept of inflation is important, but it is also important to understand how it is measured and how it affects our daily lives. In this section, we will look at how inflation is monitored and what consequences it can have.

• Consumer Price Index (THI): The CPI is the most common measure of inflation. It monitors the prices of a given basket of goods and services over time and calculates their price change as a percentage. The CPI gives an idea of how much the average person is forced to spend to maintain their quality of life.
• How does inflation affect us all? Inflation affects people on different incomes differently. Wages may not always keep pace with inflation, so it can significantly reduce the purchasing power of people on low incomes. It can also increase the volatility of food and energy prices, which affects most those who spend most of their income on basic needs.
• Unexpected inflation: Unexpected inflation can be particularly damaging. Savers who had hoped to use their savings in the future may find that their purchasing power is lower than expected. Borrowers, whose repayments become higher in real terms, may also be affected.

The devastating impact of inflation in real life 

Inflation may not seem scary when it's just a number in a news article, but its consequences on people's lives can be devastating. Let's look at some historical examples where high inflation has devastated economies and people.

• The Weimar Republic in Germany (1914-1923): In the aftermath of the First World War, huge amounts of money were printed in Germany to pay for the war. As a result, money became almost worthless. Prices soared, people used the money as wall paper and wages failed to keep up with inflation. This chaos helped the National Socialists to rise to power.
• Venezuela (2014-present): The Venezuelan economy has been suffering from extremely high inflation for years. Food, medicine and other basic necessities have become unaffordable for many people. Millions of Venezuelans have fled the country in the hope of economic livelihoods.

More than cash: exploring alternative investment strategies

Given the constraints on cash in times of inflation, investors need to explore alternative strategies to preserve and potentially grow their assets. Here are some potential approaches:

• Shares: Historically, equities have performed well in periods of inflation. While stock prices may fluctuate in the short term, they tend to outperform inflation in the long run. Investors may consider broad index funds or actively managed funds that focus on sectors that benefit from inflation, such as consumer staples or energy.
• Real estate: Real estate can be a valuable hedge against inflation. Property values often rise with inflation and rental income can provide a stable inflation-adjusted cash flow. However, real estate requires a large initial capital investment and ongoing management.
• Goods: Commodities such as gold, oil and agricultural products tend to hold their value during inflation. These assets are seen as safe havens because their prices are often influenced by global factors rather than just local economies. However, commodity prices can be very volatile and direct investment in commodities can be difficult.

The psychology of inflation and investing 

Alongside inflation, it is also important to understand its psychological impact on investors. Fear of inflation can lead to investment decisions that may not be the best in the long term.

• Bear Markets: Inflationary periods can often coincide with stock market falls, or bear markets. This can make investors nervous and sell even when selling may not be a prudent long-term decision.
• Irrational buying: On the other hand, high inflation can also lead to the opposite behaviour. Investors may look for investment opportunities that promise high returns despite the risks involved.
• Avoiding emotional investing: In times of inflation, it is particularly important for investors to avoid emotional investing. Rather, they should focus on a long-term strategy and a diversified portfolio.

Choosing the right strategy: Diversification is key

There is no "best" investment strategy for inflation. The optimal approach depends on your individual risk tolerance, investment objectives and time horizon. It is important to diversify between different asset classes in order to hedge risk and achieve a balanced portfolio that can withstand inflationary periods.

Summary

Cash may have been king in more stable economic times, but inflation has dethroned it. By understanding the challenges of inflation for cash and exploring alternative investment strategies, investors can develop a plan to protect their assets and achieve their long-term financial goals. Remember that consulting a financial advisor can help you tailor your investment strategy to your specific circumstances.