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INVESDOR INSIGHTS | 10.06.2022
You have certainly noticed that filling up your tank has become significantly more expensive in recent months. Although the so-called “tank rebate” cushions this somewhat (in some countries), the prices of petrol and diesel have reached historically high level this year. However, price increases are not only noticeable at the petrol pump – more generally, the cost of energy has risen rapidly.
One indicator of the general price increase is the inflation rate, which climbed to a new record high in Finland in April and reached 5.8 percent. In concrete terms, this means that the price for the same good has increased by 5.8 percent compared to the respective month of the previous year.
In the euro area, it's as high as 7.4 percent and expected to rise above 8 percent in May. In Germany inflation reached an all time high in May and now stands at 7.9 percent. To put this into perspective: inflation in Finland and Germany cannot yet be classified as hyperinflation – hyperinflation is only reached when inflation rates are around 50 percent.
Economists consider inflation of two percent to be healthy, however, we are currently a long way from that. But in some industries we are already approaching this critical level: In April, the increase in the price of heating oil and other fuels compared to the same month last year was 48.4 percent in Germany.
One reason for the sometimes dramatic price increases is the war in the Ukraine which has served as a catalyst for increasing inflation rates since its start. In addition to this interrupted supply chains caused by the COVID-19 pandemic and the significant price increases at the upstream economic levels are resulting in supply-chain bottlenecks. As these major events continue to play out, energy products and other goods such as food have become increasingly expensive.
Inflation describes the gradual decrease in the value of money. It often determines profit or loss, especially in times of low interest rates. Although there are currently indications that the world's most important central banks are moving away from a negative or zero interest rate policy, investors will still have to wait a while before interest rates return to pre-financial crisis levels. Therefore, they should keep an eye on inflation and protect themselves accordingly.
We will now show you the forms, causes and effects of inflation and how to effectively hedge your capital against it. Don't let yourself be horribly dispossessed. Learn the appropriate ways to protect your capital now.
The stock market offers direct protection against inflation: Inflation-linked bonds. These bonds are linked to the inflation rate. If the inflation rate rises, so does the interest rate. The reverse is also true.
However, these bonds are not necessarily suitable for newcomers to the stock market. There is often a lack of transparency and hidden costs associated with this form of investment.
To really hedge against inflation, value your money:
You can only achieve real protection against inflation by investing your money profitably. This is the best way to counteract inflation. The beauty is that this will not only protect you from inflation, but simultaneously increase your capital.
The following asset classes are subject to fluctuations in value - but in the long term the trend is upwards. Inflation is also helpful, even if it is only moderate.
Attention: Please note that higher yields are associated with higher risk. With higher yields you can counteract the inflation rate, but of course higher interest investment forms include new risks.
The importance of diversifying your investments cannot be emphasised enough: If you want to protect your money, you should diversify your capital, i.e. spread it over many investments and investment categories, in order to avoid cluster risks. Diversification is a risk management strategy in which you invest in a variety of different assets, which can reduce the risk of major losses for you in the event of increased market volatility.
You can achieve diversification through various forms of capital, for example debt and equity. At Invesdor, you will find both options. Among other things, we offer subordinated loans as a form of debt capital, while shares or similar investments give you the opportunity to become involved through equity capital.
Another approach to investing as diversely as possible is to spread your investments across different markets, thus avoiding cluster risk as you are not limiting your investments to one country. At Invesdor, we offer you investment opportunities with strong companies from many European countries - combining support for the European economy with sensible risk management.
Last but not least, you should also diversify across different categories of companies, from up-and-coming young companies to established traditional medium-sized companies, always weighted according to your personal risk profile, of course. At Invesdor, we offer you all this - the choice is yours.
Like real estate or precious metals, shares are tangible assets. This is because behind the shares are companies with associated real assets such as factory buildings, machines and personnel.
They serve as relatively good protection against inflation because usually prices go up when the money supply goes up. As always with shares, it depends on which shares you own. If companies manage to pass on the cost increases caused by inflation, then you as a shareholder benefit from inflation.
However, the prerequisite for this is that the real wages of the customers keep up. If the purchasing power of a company's customers declines, prices cannot be passed on to them. The customers can no longer afford the company's products or services.
Here it is always a question of the right measure. Studies show that shares perform best up to an inflation rate of five percent. Higher inflation rates, on the other hand, cause serious problems. However, when this is the case it usually affects the entire economy including other asset classes.
Therefore, shares are suitable protections against inflation when experiencing a moderate to increased inflation rate of up to five percent. Beyond that, many unpredictable risk factors come into play. Of course, this relies on having the right shares. Even without strong inflation, even in a functioning economy, a company can go bankrupt.
In the long term, a share investment should beat an inflation rate of two percent. So far, the DAX, the largest German share index, has generated an average plus of eight percent per year. Your real return would therefore be plus six percent per year and thus far above inflation.
Profits of individual companies also suffer from rising inflation. In the past, we were able to observe that the majority of companies were able to pass on rising prices to consumers. In this way, companies were at least able to keep profits stable. For this reason, it makes sense to invest in as broadly diversified equities as possible. For example, via low-cost exchange traded funds (ETFs / index funds).
In the long term, a broadly diversified equity portfolio has always offered very good protection against inflation in the past. When inflation is moderately elevated, equities offer a good environment for price gains. However, if the inflation rate rises rapidly, share prices can temporarily suffer more from the negative macroeconomic effects.
"What could be safer than an investment in concrete and steel?” What sounds plausible at first glance often turns out to be a misconception.
A property works well as a protection against inflation if you, as the buyer, pass on the higher costs to the tenants. Because as inflation rises, the running costs for maintaining the property also rise. Financing costs can also increase if you do not have a fixed-rate agreement with the bank or if it expires. If rents do not increase in proportion to costs, you as a landlord make a loss. Strong and rapid rent increases are usually difficult to enforce against tenants. During a period of strong inflation or even hyperinflation this immediately becomes a large problem.
However, the property is quite good protection if you sell it during a period of high inflation rates. As inflation rises, so do property prices, so you may be able to sell your property for a much higher price than you originally paid. To do this, of course, you need a buyer who is willing to pay the higher price. But beware of property bubbles!
If you do not have sufficient capital to purchase your own property, you can also participate in real estate funds. This way, participation in the real estate industry is possible even with small amounts.
Also beware of the state: Theoretically, it can impose special taxes and forced mortgages at any time. In 1948, this was done during the currency reform.
As a tangible assets, real estate is also suitable as a long-term protection against inflation. But beware: If the financing and management costs increase more than the current income due to inflation, a deficit can arise.
The expansion of infrastructure will remain an important topic in entire the world for a long time to come. In addition to bridges, motorways and airports, there have recently been investments in communication networks and renewable energies. In addition to individual investments, funds are increasingly being offered that bundle various infrastructure projects. An investment in infrastructure funds can therefore be worthwhile, especially because most offer an above-average return. The demand is enormous and will continue to grow.
Infrastructure funds offer comparatively high stability and predictability. The companies in which the funds are invested are often "quasi-monopolists". They are secured by long-term contracts and are less dependent on economic cycles. Therefore, infrastructure funds are well suited as a supplement to inflation protection.
These funds are characterised by consistently high demand and predictability. As tangible assets, they are an interesting form of investment for inflation protection, as rising operating and maintenance costs can usually be passed on well to consumers. However, often they are not readily available private investors as an investment.
Unlike paper money, gold cannot be multiplied indefinitely. That is why it enjoys a good reputation as a "crisis currency". Gold is also independent of states or central banks.
Furthermore, gold is one of the oldest means of payment in the world and transcends cultures. Even the Romans paid with gold coins.
However, the value of gold always depends heavily on the market price. There is no guarantee of rising gold prices with rising inflation. Gold is not that dissimilar to paper money and cryptocurrencies like Bitcoin, Ether & Co. In the end, it is only worth as much as people believe in it. You can't eat it or directly produce anything with it, nor can you live in it.
The past has shown: The inflation rate and the gold price do not necessarily behave as one would expect. Examples are the years 1980 and 1981, when inflation was very high but the gold price did not rise. On the other hand, the gold rally between 2001 and 2005 cannot be explained either. Inflation was on the decline at that time.
Finance professor Andrew Ang from Columbia Business School empirically proves in his article "Real Assets" (2012) that gold is not a good inflation hedge. According to his research, the gold price developed at a much weaker rate than inflation over long periods between 1875 and 1970.
This shows that inflation is not the sole cause of increased demand for gold. Rather, it is the fear of instability in the monetary system. Fear causes the demand for gold to rise. And this instability can be triggered by high inflation. A disadvantage of gold is also that it does not yield interest or dividends. Additionally, the past has shown that with gold, the entry point is extremely important but difficult to find. If you enter at the wrong time, you often have to wait a very long time before you even get your investment back. Other precious metals such as silver or platinum are always alternatives to gold.
Also consider the storage costs for gold, especially for larger quantities. Gold must be safely stored and protected. Both from burglars and from damage. Safe depositories and protection regularly cost money. Due to inflation, the costs for these services are also rising.
Experts recommend investing five to ten percent of the portfolio in gold or other precious metals as an emergency reserve in the event of a crisis. Investors should always see their gold investment as a long-term investment and crisis currency in the event of price fluctuations.
In the case of a crisis gold is a protection which has withstood the test of time. In particular, concerns regarding the stability of the (paper) monetary system regularly increase the demand and thus the price of gold. The sometimes high fluctuations of the market price, the lack of dividends and the storage costs are problematic.
Corporate bonds offer an alternative to shares. Many companies can no longer and no longer want to rely solely on banks for their financing. They are looking for additional sources of financing through the stock market. Through a bond, you provide the companies with the financing they need and earn interest at the same time.
With corporate bonds, the creditworthiness of the company plays a crucial role: You should know the answer to the question of how good the company’s future solvency is. Because the company can only service the interest and redemption payments due with a good credit rating. Simply put, the higher the risk, the higher the interest rate. In most cases, large corporations’ bonds offer lower interest rates than medium-sized companies’ bonds, but their creditworthiness is often higher.
If the interest rate on corporate bonds is above the inflation rate, this offers protection against the loss of purchasing power due to inflation. However, bond prices usually fall when inflation rises. As a protection against inflation, they are therefore only suitable to a limited extent.
Crowdlending makes it possible to invest in loan projects of (mostly smaller) companies. In return, investors receive regular interest and redemption payments. Crowdlending at Invesdor offers an average interest rate of over five percent per year.
It is important that the borrowing companies meet their payment obligations to the investors. If this works, you should easily beat inflation with crowdlending. The risk here lies in stronger rising inflation. Compared to the default risk, the investor is now only rewarded with a comparatively low interest rate.
A special feature of crowdlending is that you receive interest and principal payments at regular intervals. This allows you to divert some capital from crowdlending into other asset classes if necessary. It thus offers a bit more flexibility than corporate bonds or shares, which can only be liquidated at a loss if necessary.
Crowdinvesting can also be a way to protect against inflation. Here you invest in companies for the long term. The opportunity here is high returns in the event of success, which far exceed the usual interest rates for loans.
Crowdlending and crowdinvesting offer above-average interest rates. Especially in the current low-interest environment, this offers an interesting alternative. In terms of risk profile, they are similar to shares and corporate bonds. However, in the event of extremely high inflation, even these forms of investment will no longer serve as sufficient protection against it.
|Suitable as inflation protection||Limited suitability||Not suitable|
|Shares & Equity ETFs||Gold (in future cryptocurrencies such as Bitcoin)||Call money / time deposit / savings book|
|Real estate / real estate funds (note running costs!)||Corporate bonds||Art, jewellery and other valuables|
|Infrastructure fund||Crowdlending & Crowdinvesting|
You may have noticed: The practical implementation of inflation protection is difficult in low-interest phases. That is why we have drawn up a list of notes for you to use as a guide.
Inflation is a constant companion of our monetary system. Don't be intimidated by it, but always remember the real loss of value. In the current low-interest phase, you as an investor must behave proactively to protect yourself from inflation.
The information contained herein is not meant to be, and it shall not be interpreted as investment advice or a recommendation and investors must neither accept any offer for, nor acquire, any securities unless they do so on the basis of the information contained in the applicable investment material of a target company. Investing in securities of unlisted companies is associated with high risk.