The annual inflation rate in the United States has already reached 6%, inflation is raising its head. How is the continuing rise in prices affecting our consumption and what should we do.
The publication of the US price index last week, which showed an annual inflation rate of over 6%, heralds a fundamental change in the basis of our financial conduct: the inflationary environment. After many years in which inflation was low, even less than the Bank of Israel’s annual inflation target (1% -3%), now the price increases we are feeling everywhere are translating into the official index. What does this actually mean and how should it be conducted?
Erosion in purchasing power
Inflation is a situation where there is a general and sustained rise in prices, resulting in a decline in the value of money. That is: the same currency can buy less. The reasons for inflation are varied: it can also be due to an increase in product prices, such as the increase in the transportation of goods in the world due to the corona, but also an increase in the supply of money, which is called “money printing” in the vernacular. When central banks and governments print money to support the population, this is reflected in the corona era: economies have increased the supply of money held by citizens through grants and economic support. An extreme state of inflation is called “hyperinflation”, in which the value of money erodes quickly.
In addition, it should be borne in mind that the rate of inflation is determined by the increase in the official price index, but there are many price increases in products that do not take part in the index, especially housing prices.
The monthly budget should be redesigned according to the new price level: keep a closer eye on the expenses, and if you see an increase in the level of expenses, adjustments need to be made: either re-prioritize the expenses. But one should be aware of the changes that are taking place and not proceed automatically, even if it may be difficult to see these changes with all the shopping holidays, which just tell us how everything is cheap, available, and can be ours effortlessly.
A point worth paying attention to routinely, and especially during this period, is the effect of inflation on the mortgage, and especially on the viability of the adjacent tracks. The classic mortgage consists of three tracks: a prime track that depends on the increase in the interest rate at the Bank of Israel, a track of an interest rate that changes every few years, depending on a change in the predetermined anchor, and a fixed interest track. The last two tracks – the anchor and the fixed – can be taken index-linked or non-CPI-linked.
When taking out a loan, the CPI-linked route will be cheaper than the unlinked alternative. For example, an attached fixed will be cheaper than an unlinked fixed. The difference in prices in both cases embodies inflation expectations because if you choose an unlinked interest rate, you actually “bought” the inflation risk and took advantage of it. If you are undecided between an unlinked and unlinked route – pay attention throughout the period to the loan repayment. If we are talking about a period of 30 years, the risk of inflation is a substantial risk.
If we look at the money investment side, it seems that our money needs to be protected from erosion. Its erosion will occur if the rate of inflation is high, and the money is sitting in plans that do not yield a return at least at the level of inflation. If we pay high management fees on the savings-investment, the money will be wasted if it does not yield a return on inflation plus the management fee. This pushes investors to invest at high levels of risk – especially in the shares of companies that are growing back after the corona and companies that are expected to raise prices due to the general wave of rising prices, or in anti-inflationary assets.
Anti-inflationary assets are assets whose purchasing power has not been affected by the weakening of currencies, such as various commodities (gold, copper, wheat), and the hot anti-inflationary asset of recent times is bitcoin in particular and the world of digital currencies in general. High risk and volatility.
Investing in stocks is one way to protect the portfolio from inflation – the return that the portfolio will yield should in the long run compensate for the erosion due to inflation. However, it should be remembered that stock markets are at their peak and at high price levels. In addition, one way to fight inflation is to raise interest rates, which may incentivize declining markets. Therefore, it may be worthwhile to pay attention to sectors that can actually benefit from rising interest rates and inflation, such as, for example, banks, or at least be less affected by it – such as shares of commodity producers. Investors in the debt world can buy index-linked bonds that protect against inflation, but because inflationary expectations are embodied in the price of bonds, the return they will provide will be nil to low. They can be used as a hedge against an inflation scenario, rather than as a yielding asset.
