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Diversify your investments to guard against inflation

Hellen Njeri @PeopleDailyKE

When investing always plan on how you can guard against inflation or rising cost of living.

Some of these are going to relate to things you can do in your portfolio and some are going to be more general about your overall finances. Well, throughout the course of your life, you probably noticed that the cost of living has increased.

How can you protect yourself against inflation and maintain the same standard of living throughout your retirement? Below are some investment strategies:

-Bonds

Many investors, particularly as they near their sunset years and enter into retirement, pick bonds for their portfolio. Bonds provide the anchor and the stability of a diversified portfolio.

Another word for bonds is fixed income securities, and the reason investors use the term ‘fixed income’ is that the interest payments are fixed.

For example, if you invest a Sh1000,000 in bonds and get 12 per cent interest a year in income, maybe that’s a good return today and helpful for your retirement goals, but what about in 10 years or 20 years down the road? Will that 12 per cent still provide you with the same lifestyle? Perhaps isn’t enough.

With bonds that income is often fixed. So how can that be mitigated?

First of all, you can focus on short-term bonds. By focusing on shorter-term bonds, you have less exposure to future inflation. This is due to the fact that when bonds mature you can go out and buy new ones or you can do better investments with less risk. Interest rates tend to rise with higher  inflation rates.

Picture yourself in retirement and instead of a 30-year bond, you own a four-year bond. Inflation is rising, your cost of living is increasing, and so are interest rates.

In four years, when your bond matures, you take the proceeds and you go out and buy a new bond at a higher level of interest. This generates more income which will now cover your expanded cost of living. That’s the beauty of short-term bonds as opposed to being locked into a very long maturity bond.

-Stocks

Moving from bonds to stocks can also provide a great hedge against future inflation. Stocks provide inflation protection in two main ways. The first is that stocks often pay a dividend whereas bonds, generally, pay a fixed amount.

Specifically, if you invest in bonds today, your cash flow never increases. Dividends are different: as companies grow their profits, over time, the dividends can also increase.

If a company earns more, they may pay more in the way of dividends. Those increasing dividends lead to higher cash flow in the future, which could potentially increase your spending power and maintain or even enhance your standard of living; even if inflation is rising. Imagine a scenario in which a company dividend is 13 per cent a year. 

 

-Real estate

Property can be a great inflation hedge. Over time depending on the part of the country that you invest in, you may have noticed that home prices have increased dramatically overtime.

Certainly, there are blips along the way and sometimes sharp, but over time real estate prices have tended to increase more or less in line with the rate of inflation. If you own rental real estate you may get rising rents in an inflationary environment.

That ability to increase your future cash flow gives you an inflation hedge if your cost of living commensurately increases. Maybe it’s owning physical real estate that works for you.

-Control expenses

The final way to protect yourself against rising inflation is not on the investment side but instead on your expense side. The big danger of inflation isn’t some arbitrary number in the economy, it’s that the money that you have to spend every month increases.

What if you could lock in some of your expenses? In fact, you can: one of your biggest expenses in retirement may be real estate, your mortgage on your home, or other fixed loans such as a car payment. Fixing the rate of interest on your liabilities is a way to hedge against inflation because you are no longer subject to rising expenses.

If your mortgage is fixed or your car loan is fixed you know, with certainty, what your expenses are going forward regardless of the inflationary environment.

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