Investors often keep a watchful eye on nominal returns, celebrating gains and lamenting losses. However, hiding beneath these surface-level numbers is a silent wealth eroder: inflation.
In 2022, inflation spiked to levels not seen for decades, with the global headline number at 8.7%. As a result, central banks worldwide initiated a series of forceful interest rate hikes to try and rein it in. The International Monetary Fund expects global inflation to decline in 2023 compared to last year, yet many still have expectations of another upward rise.
Inflation can stem from various sources, exerting a range of different effects on investments. It disguises the actual value of assets and threatens purchasing power. Therefore, taking a closer look at the domain of inflation-adjusted returns and asking important questions is crucial.
What are the best investments in times of high inflation?
- During inflation, how do gold and silver measure up against conventional assets such as stocks and bonds?
- Can precious metals serve as a vital hedge against the insidious impact of inflation on investments?
Understanding Nominal Returns
Before exploring the world of inflation-adjusted returns, it’s essential to understand the basics of nominal returns. Simply, nominal returns are the gains and losses visible on your investments before taking into account other expenses like investment fees, taxes and inflation.
Nominal returns are often used to evaluate investment performance. They are the number on the surface, but looking at the inflation-adjusted returns is vital to see the true value of your assets.
The Hidden Impact of Inflation
Inflation, the gradual rise in the prices of services and goods, can significantly impact investments over time. It can stealthily decrease the real value of investments if not carefully monitored. With its erosive potential, it is important to protect yourself against inflation.
When inflation rises, the purchasing power of your money diminishes. Your money will no longer stretch as far as it did before. For example, if the rate of inflation is 7%, typically, prices of goods are 7% higher than that time the previous year. If you had spent £100 on something, you’d now spend £107 and so on.
For investors, this means the worth of their investment won’t be as great in the real world as it had been. While the cost of everything else has risen, their purchasing power has lessened.
However, when the inflation rate falls, this doesn’t always mean product and service prices will follow. Inflation can fall because prices are not increasing as rapidly as in previous years. The prices may still be growing, but just not as quickly.
What Are Inflation-Adjusted Returns?
Inflation-adjusted returns, or real returns, give a true assessment of how your investments are faring. They calculate the inflation-adjusted returns by subtracting the inflation rate from the nominal returns.
Investors should prioritise seeking investments that maintain returns at least equal to the inflation rate.
Falling short on returns means their investments are effectively losing value. For example, if an investment yields 6% (in nominal terms), but the inflation rate stands at 7%, the real rate of return is, in reality, a negative -1%.Kinesis provides two inflation-resistant digital assets, namely KAU and KAG. These digital assets are backed by fully allocated physical gold and silver, respectively, allowing holders to capitalise on the enduring value of precious metals while also receiving a yield.
Comparing Investment Performance
Investors need to evaluate how different asset classes will perform in periods of fast-rising inflation. While some may suffer to keep their worth, others may have the potential to match the pace of inflation.
We can see how these investments compare in terms of behaviour and their inflation-adjusted returns.
- Stocks: Historically, many stock market sectors have shown a propensity to outpace inflation, offering positive inflation-adjusted returns. The energy stocks have shown growth in this time of rising inflation, where others suffer from a weak market and reduced consumer spending. However, stock markets are inevitably susceptible to volatility, affecting their ability to preserve purchasing power.
- Bonds: Though typically considered less volatile than stocks, bonds often struggle to match up with inflation. Fixed-income investment bonds are significantly affected by inflation – as inflation increases, the interest rates for the bonds remain the same, causing investors to look for alternative investments. Other bonds are subjected to rising interest rates that move with inflation, decreasing the value of existing bonds.
- Gold and Silver: Precious metals like silver and gold have long been regarded as hedges against inflation. Time and time again, gold has shown a positive correlation with inflation, suffering only short-term volatility waves. In turn, silver has also proved to perform well as an inflation hedge, although it has shown a slight lag behind the movements of gold. Regardless of these dips, they still provide attractive options for wealth preservation.
Gold and Silver as Inflation Hedges
So, why are gold and silver seen as great inflation hedges? Unlike fiat currencies or paper assets, precious metals possess an intrinsic value and a limited supply. This scarcity makes them less susceptible to the erosive effects of inflation.
When inflation surges, it typically leads to gold and silver prices indirectly changing alongside, bringing the real value of gold and silver up – safeguarding your purchasing power.
A common trend during economic uncertainties and currency devaluations is for investors to look to gold and silver as safe havens. As more is purchased, this further boosts their value. This dual role as both inflation hedges and safe-haven assets solidifies their appeal in the investment world. Take a look at how the price of gold and silver has correlated with the CPI index over the past 32+ years.
Illustrating the impact
To illustrate the impact of inflation on investment returns, you can think of it like this: If you invested in a stock portfolio that yielded a nominal return of 7% over a year – this may seem like an attractive investment. However, if the inflation for that year were 3%, then your real return, after accounting for this, would, in fact, be 4%. While your nominal return was 7%, your purchasing power only increased by 4%.
Contrast this with investing in gold, which also yielded a nominal return of 7% during the same year. Since gold tends to maintain its value during inflation, your real return would also be 7%, effectively preserving your purchasing power.
Understanding the impact of inflation on your investments is crucial for making informed financial decisions. It’s important not to take nominal returns as the deciding factor when comparing the assets. To secure your financial future and protect your wealth, consider diversifying your portfolio with assets like gold and silver, with a proven track record as inflation hedges.
In a world where the value of money is continually under pressure from inflation, safeguarding your wealth with assets that resist its corrosive effects is a wise strategy.
To find out more about how you can invest in gold and silver, click here.Or, if you would prefer to explore digital currencies, Kinesis gold and silver accounts are backed by physical gold and silver and offer a Kinesis Virtual Card that allows you to use your account as an actual currency.
Latifa maintains an agile, sociological understanding of the dynamic concepts of money, currency and their global impact. Her work on technology reshaping the remittance industry and the evolution of money has been featured in Global Banking & Finance Review and The FinTech Times.
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