Money kept in the bank or in money market funds is susceptible to the ravages of inflation. The deceiving part is this; while your balance wont decline, the values of the goods and services you can buy with your dollar is falling. Therefore, if you don’t put your money into something that keeps pace with inflation, you’ll soon find your savings buys less and less.
As an investor, you need to be prepared to do battle with inflation. Inflation comes about when there is too much money chasing to few goods, so prices are driven up due to the increase in the money supply. When high inflation is afoot, it quickly decimates savings accounts and investment portfolios. However, not all investments do poorly when inflation is high. Gold tends to do well during periods of high inflation and can be a good hedge against inflation risks.
Traditional stocks and bonds usually outpace savings accounts; however they are still a poor match against inflation. Inflation also very damaging to fixed income investments such as bonds. A bond pays out a fixed rate of return each year, and inflation cuts into this annual return. Say a bond pays an interest rate of 6% and the rate of inflation is 4%, the net return on this bond is actually 2%, and if inflation really takes off, it is possible for bonds to earn a negative rate of return. Therefore, bonds are real problem investments during periods of high inflation. High inflation drives up the prices in an economy and reduces the profits of companies. Since inflation also reduces the value of the currency, the profits produced by an economy are also worth less overall. As a direct result, stock prices may rise and fall during times of inflationary tumult, but they usually don’t keep up with inflation.
Inflation’s Impact On Gold
Since Gold is a commodity it tends to rise in tandem with other commodities so, it doesn’t get hurt by inflation. In other words, as the value of the paper dollar decreases the value of gold, silver, food, oil, etc., all rise. And so, precious metals tend to keep up with inflation over the long term. When people fear the effects of inflation, or mistrust Governments or financial markets, they tend to flock to Gold thus boosting the price and allowing the metal to retain its dollar denominated value.
Inflation’s Impact on the Economy
Inflation and it’s effects can be very harmful to the economy. Inflation can be seen as contributing to the uncertainty of business decisions and monetary transactions, both nationally and internationally. What will the value of the currency be next month, next year or 10 years from now? This uncertainty causes businesses and individuals alike to assume less marketplace risk, and thus the overall economy grows at a slower rate than it would have without the uncertainty inflation brings to bear, and this can often lead to a recession.
This is another advantage for a gold as an investment. When the economy is doing poorly and worries abound, investors tend to allocate large amounts of capital towards more stable assets like gold. This pushes up the market price of gold. If some of your portfolio is invested in gold, it can help offset the losses from your other investments and create a more balanced strategy. Allocating your resources for gain is a never-ending battle against various financial risks. By diversifying some of your assets into gold, you can make sure that you are protected against the risk of inflation.