In economics, inflation and deflation are factors that you
have to consider when planning and managing your investments.
By definition, inflation is the rate at which the prices of
goods and services rise. On the other hand,
deflation is characterized by a general decline of prices of goods and
services. That tells us that inflation
and deflation are obviously the sides of the same coin.
Now, it’s sometimes easy to detect where the economy is
headed. It’s easier to decide which
action to take next. However, deciding
what do during uncertainties can be quite tough. And this article pretty much sums up what you
need to do in such uncertain times.
Inflation
As time goes by, prices for everything—from a bottle of soda
to a new gadget—tend to increase. When the
jump in prices become too much, both the consumers and investors can be faced
with challenges. That’s because as inflation
goes up, their purchasing power can fall very quickly.
How to Protect Your Portfolio from Inflation
There are many quite popular strategies you can use when trying
to protect your portfolio from inflation.
The first one is obviously the stock market. This is because jumping prices is generally good
news for the equities market.
Meanwhile, for fixed-income investors searching for an
income stream that can catch up with rising prices, the Treasury Inflation
Protected Securities, or TIPS, can be a good option. These bonds are issued by the government, and
they come with a guarantee that their par value will increase along with
inflation, as gauged by the consumer price index. Meanwhile, their interest rates remain fixed.
The interest on TIPS is paid semi-annually. The bonds can be bought directly from the
government through the Treasury Direct system, with $100 increments and a
minimum investment of $100.
Deflation
Deflation is a lot less common that inflation. This takes place when a lower level of demand
in the economy leads to a steep drop in prices.
Most of the time, deflation coincide with periods of high unemployment
and economic depression.
How to Protect your Portfolio from Deflation
When deflation threatens investors, they usually stick to
bonds. High-quality bonds usually
survive better than stocks in such times.
This bodes well with the popularity of government-issued bonds. Foreign bonds are also favored in these
periods.
As for stock investors, companies that cater consumer goods
that people must buy no matter what tend to be the go-to place for
investors. These are more usually
referred to as defensive stocks.
Dividend-paying stocks are also a good option among
equities. Cash also becomes more popular,
as well has certificate of deposit and saving accounts.
Conclusion: Gearing Up against Both
In many cases, it’s difficult to really know if inflation or
deflation is the worse threat. The idea
is that if you’re not sure which one to prepare for, prepare for both. You have to have a diversified portfolio that
has allocations across investments that bid well during inflation and that
survive during deflation.
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