It would be nice if inflation would just go away, but that doesn’t appear to be on the verge of happening any time soon. While the Fed and certain other economists like to wring their hands about the possibility of short-term deflation, that’s just a red herring. The broader trend has been greatly tilted to the inflationary side for the last 40 years and there’s nothing we can see that will change that.
When the Fed talks about deflation, ignore their chatter. Inflation is the thing to plan your investments around because inflation is the thing that’s not going away. Once you have that idea firmly seated, it only makes sense to plan your investments accordingly. Before we go further, let’s find a short but solid definition of the term so everyone understands exactly what we’re talking about.
Here’s how Investopedia explains it:
Inflation is the rate at which the general prices for goods and services rise, and, subsequently, purchasing power is falling. Central banks attempt to stop severe inflation, along with severe deflation, in an attempt to keep excessive growth of prices to a minimum.
In inflationary times, your money buys less with each passing year. For example, if the inflation rate is 4% (which is a typical, laughably low government claim), then a $1 pack of gum will cost $1.04 in a year. An increase in price of four pennies hardly seems worth the effort to pay attention to, but bump the inflation rate up to around 10% (which is closer to reality) and let it play out year after year, decade after decade. Now you’re starting to notice that the .25 cent candy bar from your youth now costs almost two bucks.
To summarize, inflation means the amount of stuff you can buy with your money is less. Your money is devalued. What does this have to do with investing? Quite a bit actually. The paper money and coins in your pocket aren’t the only assets that lose value. So does anything else you own that is valued in terms of currency. For example, stocks, bonds, mutual funds.
Oops. That takes in most of Wall Street’s offerings. Does that mean your stock-based portfolio is losing value? Sorry but yes. Even though you might see the balance rising in your investments, unless your ROI exceeds the rate of inflation, which we seriously estimate to be close to 10% annually, you are either treading water or going backwards.
Is there a way out of this mess?
Actually there is. It’s called income property investing and it appears to be the only form of investing that actually thrives on inflation. The reason is that, thanks to the fact that you are borrowing money to buy the thing and continue to periodically refinance it, you never hold much currency related to your investment. But someone’s got to be taking the inflationary hit in the deal, right?
That’s quite astute of you and absolutely correct. Who holds a balance due in terms of money? The bank, that’s who. They are the one losing value as the principle declines in real terms of purchasing power. This is why it’s better to be the borrower than the lender in the presence of inflation, though you shouldn’t shed too many tears feeling sorry for the bank. They’ll make their money up in interest and other seemingly random and never ending fees.
The bottom line is that your goal should be to NEVER pay off a mortgage tied to a piece of income producing property. The moment the mortgage is gone you now own an asset that is valued in terms of currency, which is constantly declining. Don’t worry if you have a hard time wrapping your mind around this idea right off. It’s a different way of thinking. The simple heart of the matter is that, as long as we have inflation, a long-term, fixed-rate mortgage tied to a piece of rental property is your best bet to create financial independence, and since it’s a safe assumption our nation will never return to the gold standard, we can assume, for all practical purposes, that inflation is here to stay.
The good news is that while everyone wrings their hands and gnashes their teeth, you can rest easier at night comforted by the knowledge that your assets are increasing in value while you sleep. For the guys and girls still hung up on Wall Street, the future’s not looking quite so bright (Top image: Flickr | opensourceway).
The Heroic Investing Team