Definition of inflation 

The impact of inflation on investment is among the most common risk factors that the ordinary investor overlooks. This aspect, however, might affect an investor’s projected return and time horizon by allowing them to consider the real implications of their macro condition. Let’s say you are saving for your first flat or home. You search for it and eventually find a stunning home in the ideal neighbourhood, priced at $100,000. You calculate that raising the required 30% deposit of $30,000 will take a year based on your current salary. But you should have accounted for inflation. The current 5% interest rate impacts the initial analysis. While the $ 30,000 will remain a constant goal, the decrease in purchasing power of every dollar saved and increased living costs caused by inflation will likely affect the ability to reach the goal, making using a savings strategy necessary to meet the target. 

Importance of understanding inflation for investors and individuals

Inflation has the same effect as soil erosion on an investment portfolio; when not addressed, it slowly chips away at the overall value of the investment returns. When individuals are unaware of the effect of this constant leakage, then investment objectives are not met in the expected horizon. Saving for the house suddenly takes longer to make a deposit. 

Now, even with a more prudent investor, the cost of inflation still affects them. Once they understand the concept of natural and nominal returns, inflation has a macroeconomic effect. 

How Inflation Impacts Investments and Savings

As an investor, the objective of investing is capital growth with the intention that at a later date, the redemption of the investment will meet an economic need. However, the macroeconomic nature of inflation is that the cost of meeting that economic need increases within the time frame of the investment. So, the price of the home that the investor was saving to buy instead of costing 100,000 at the end of the year now costs them 105,000. Assuming the investor has a return rate on their savings account of 3.12 per cent, the investor has a savings of 103,120. The investor is now already behind on the goal due to inflation. However, if the investor has a savings of 6%, just above the inflation rate, the savings are 106, 000 which is relatively in line with the cost of the house. 

So What is Inflation Risk 

Inflation risk is the probability that an investment’s purchasing power decreases due to inflation over the investment horizon. When the government changes its policies or changes the supply of goods and services, the risk of inflation goes up. When more money is floating around in the economy, there’s a bigger chance of prices going up, thanks to increased consumer spending. This means that any investments you have might not go as far as they used to regarding buying power. So, Inflation risk is the risk that your money will lose its purchasing power.  While inflation risk has short-term effects, the broader impact of inflation risk comes into play when analysing investments over a more extended horizon period. Knowledge of inflation risk makes an investor more prudent about actual returns and the impact of market-associated or systematic risk factors. 

Inflation Risk is a Systematic risk factor, which means it is always present in the market and tends to price based on information available. Thus, the whole market, to some degree, is inherently affected by inflation risk. As inflation risk is inherent in the market, diversification does not shift or eliminate this risk. However, the only way to mitigate this risk is to have an appropriate asset allocation strategy. Using an investment portfolio with non-correlated asset classes can help an investor minimise the risk that purchasing power will erode over time. 

Mitigation of inflation risk through the Stackr App 

The Stackr Trust, through its app, provides investors with the tools to make decisions and mitigate the effects of inflation risk through digital asset exposure. Digital assets have a lower tendency to be affected by Systematic risk. Traditional approaches to risk management in tactical allocation portfolios have shifted to gold in times of inflation. Bitcoin has the potential to mimic gold, as the cryptocurrency is scarce and therefore offers investors protection as a commodity substitute. If Bitcoin is gold, then one may consider Ethereum digital silver. Like gold, the primary use of gold is as a store of wealth, whereas Ethereum and Silver are both stores of wealth and maintain utility. The Stackr app is designed for a longer-term investment strategy and, as such, makes an investor journey to owning a bit of Crypto exposure. Ethereum, Bitcoin and several other actively managed crypto funds are available on the app. Register today to start protecting your investments from inflation risk.

Disclaimer:

The information provided in this article is for informational purposes only and does not constitute an offer, solicitation, or recommendation to buy or sell any financial instrument or investment product. Before making any investment decisions, conducting thorough research and considering individual financial circumstances is crucial. Investing in funds involves inherent risks, and past performance does not indicate future results. The value of investments can fluctuate, and investors may lose some or all of their initial investment. It is advisable to carefully read any fund’s prospectus or offering documents before making investment decisions.

This article does not replace professional financial advice. Always consult with a qualified financial advisor before making investment decisions. Financial advisors can provide personalised guidance based on your financial situation, goals, and risk tolerance. Stackr, mentioned in this article, is not responsible for any loss or damage resulting from reliance on the information provided. Users are encouraged to independently verify and validate the information and conduct research before making investment decisions. The financial markets are subject to various risks and uncertainties, and individual circumstances may vary, so making informed decisions based on comprehensive research and professional advice is crucial.