We have to ask ourselves what’s going on in the world today, and the answer is pretty simple. Central banks have pushed so much liquidity into the system that everything looks great since technology plus huge investments thanks to low borrowing costs has kept prices down.
This tells me two things, the world can continue on as is or central banks can lose control and we could see huge inflation. As I don’t have a crystal ball, the best thing to do is to be hedged against such a situation in order to sleep well at night.
Something that’s very important to understand is that inflation is much more related to your personal finances than your portfolio. As we saw in my analysis of chapter two of The Intelligent Investor, stocks don’t really offer immediate protection from inflation, so we have to be protected from a personal standpoint.
Life & Inflation
The average inflation rate in Europe over the last 20 years was 1.72%, while the average in the U.S. was a bit higher with a cumulative inflation rate of 55%.
What’s possible is that in the next 20 years we continue to have low inflation, but it’s also possible that we have high inflation. I don’t know what will happen, but I like to be protected.
As I said, inflation is about our personal finances. Let’s look at who is protected and who isn’t.
One who buys the 30-year Treasury with a 3% rate might not be protected against what might happen in the next 30 years, but one who buys the 1-year Treasury at 2% might be much better protected thanks to the flexibility it offers. So, if you are a saver, you lose with inflation. What can be done is to be a borrower.
What I personally did was get a 30 year mortgage with a fixed interest rate for the next 20 years. So if there’s inflation in Europe in the next 20 years, I’ll do well. If the rate is around 1.7%, I’ll do okay as my payments will be fixed while if there will be higher inflation, I could do extremely well.
A note here, I bought my house here in the Netherlands when nobody wanted to buy because prices were declining. So I could choose what to buy and even lower the price. That’s impossible now, just 3 years later.
The one thing that I’ve done well with over time is to take advantage of the population’s irrational behavior. When home prices decline, nobody wants to buy anything. When prices peak, everyone rushes to buy.
So, by buying versus renting, you can protect yourself against inflation in a way. However, I’m not advocating rushing in and buying real estate now. Buying real estate is like investing in stocks, you find a sector with positive long tailwinds (demographics), you find a stock with a moat (there can’t be more penthouses around Central Park), and you find it for a good price (look at 1,000 properties, find 10that are interesting, make a very low offer for 5, and one will accept). This way, the risk is low and the return high.
Other Inflation Hedges
I recently talked about how silver is an interesting inflation hedge, perhaps even better than gold. So you can invest in silver miners and if there is huge inflation, you can expect multi-bagger returns which allow you to keep a small part of your portfolio as a hedge.
Investing in commodities is also an idea, and in real assets. The price to book value of the S&P 500 is above 3 and this includes intangibles which don’t really offer protection as they are often impaired in a recession. So to be protected from inflation, one must look at investments that have hard assets to back their values, and not much debt because inflation and higher interest are not good for such companies.