Inflation is a phenomenon that we all have to navigate through because it reduces the purchasing power of our money. Although a million naira will always be a million naira, the amount of goods and services it can purchase reduces over time as a result of inflation.
When we factor supply chain issues caused by the COVID-19 pandemic-induced lockdowns and the effects of the Russia-Ukraine war on food and energy prices, we start to understand the upward pressure on prices globally.
It is the mandate for Central Banks to keep inflation at a healthy pace in order to protect the purchasing power of our money, but the lingering question that everyone needs an answer to is how we can manage our finances in a high inflation world.
Let us split this into managing money and investing money during high inflationary periods.
Managing money during high inflationary periods
One way to navigate through inflation is to earn more income. If things become more expensive, one can simply increase their income so that they can maintain their standard of living and purchase the same things that they could purchase before.
It is often easier to reduce our spending than it is to increase our income, so what we want to do during periods of high inflation is to review our budget with the aim of saving money. One way we can achieve this is by changing our spending patterns/behaviors.
This means that when prices are going up, we need to find ways to cut out non-essential expenses and save money on necessities by buying things in bulk, finding alternatives or negotiating better deals.
Investing money during high inflationary periods
Generally, there are two categories of investment options one must consider when investing;
- Fixed return investments where you know the returns you will receive during the investment period as in the case of bonds.
- Variable return investments where the returns you receive vary in relation to the performance of an underlying asset as in the case of stocks.
Fixed return investments like bonds and treasury bills do not perform well during periods of high inflation. This is because the returns can fall in value as it is overshadowed by the rate of inflation.
Real estate as an asset class is generally considered to be a great hedge against inflation because while rental income can be fixed at the start, it can always be adjusted upwards to reflect the increase in prices.
Variable return investments like stocks are the ones that perform best in high inflationary environments because the returns received from investing in this asset class can be adjusted to keep up with inflation.
However not all stocks perform well during inflationary periods The category of stocks that do well during these periods are defensive stocks.
These are stocks of companies that produce goods and services that are essential to the population such as consumer staples, utilities and healthcare. Regardless of prices, we always need to consume these products and services. So while we cut out non-essentials expenses and services,we still patronize these companies.
How about commodities and alternative asset classes like crypto?
Essential commodities like energy and agricultural produce are great hedges against inflation because they are also necessities and will always be in demand regardless of price.
According to Standard & Poor’s, energy has been one of the best performing sectors in 2022 so far.
Bitcoin has been labeled “digital gold” in reference to its perceived ability to serve as a store of value during economic downturns. But with inflation being on the rise, the stock market has been down, and so has Bitcoin.
Since the start of 2022, Bitcoin has had the same correlation with the broader stock market, so it has not held up to its label as digital gold yet and a hedge against inflation.
In conclusion, we need to reduce our non-essential expenses during periods of high inflation by reviewing our spending habits.
It is also important that we invest in assets that perform well during high inflationary periods such as real estate and defensive stocks as fixed income assets such as bonds do not perform well during inflation..