How I Use Inflation to Get Richer
This is the week where I would normally post up an Ask Robert. Instead, I’m going to do a modified version.
A couple weeks ago, I wrote a blog post entitled “Hidden Dangers”. In that post I wrote about the hidden dangers in our economy—especially inflation. I shared how both the CEO of WalMart and Warren Buffett are certain that “significant” inflation is coming for the US economy.
In that blog I also used the phrase, “I know how to use inflation to get richer.” A commenter on the blog, Jordy, picked up on that phrase and asked if I would write a post on the topic. So, for this month’s Ask Robert, I’m going answer Jordy’s question.
Inflation will come
First off, this is an important topic because inflation will come. New events push us towards significant inflation everyday. For instance, this week a big milestone was hit as the US debt ceiling was reached.
Over the next 11-weeks, the Treasury can keep the US solvent through extraordinary measures, giving politicians a small window to reach a deal. But come August, if no deal is reached, the US will default on debt payments.
The US has two options: default or more debt. If the US defaults on debt, it will crash the dollar and diminish its purchasing power. If they raise the debt ceiling, the US will have to print more money and diminish the dollar’s purchasing power. Either way, things will cost more.
Inflation makes people poorer
Now, to some, that’s bad news because they don’t know how to use inflation to get richer. So, instead, inflation makes them poorer. For instance, employees are hurt by inflation because they can only sell their time, and time generally does not hedge against inflation well. Raises, if they come at all, generally come on an annual basis after inflation—not with it.
Additionally, people who are deep in credit card debt or who have interest ARM loans are hurt by inflation because the Fed generally raises interest rates to combat inflation. Much bad debt is based on adjustable interest rates that go up during times of inflation, making debt payments more expensive.
Finally, people who play by the old rules of money are hurt by inflation because they believe it is wise and prudent to save money in the bank. But the bank is smart, not dumb. And the bank plays by the new rules of money. They pay interest on money that doesn’t keep up with inflation. Money loses purchasing power as the bank uses your money to make more money.
Using inflation to get richer
I use a very simple formula to get richer from inflation: leverage and hedging.
I play the bank’s game. I borrow money from the bank at a fixed rate, buy a cash flowing asset that covers the debt payment, and using less of my own money increases my return on investment.
In an inflationary economy, if the debt payment is fixed, it becomes less of a cost as the dollar loses purchasing power and my investments and income grow.
The reason my investments and income grow is because I purchase assets that hedge against inflation. For instance, in inflationary economies, rents generally rise. When I purchase investment property, the debt payment stays the same while my rents rise due to inflation. This creates more cash flow. I owe the bank only the agreed payment. The rising costs for rent flow straight into my pocket.
The same thing happens for businesses. As the cost of goods rise for consumers, businesses can adjust their pricing and benefit from inflation.
This works because business owners and investors aren’t selling time. They’re selling product that hedges against inflation. They are in control. Employees aren’t in control of their product—time—nor are they in control of their money (the bank or mutual fund is).
One other thing I do to hedge against inflation is invest in commodities. Recently that has been oil, gold, and silver. These are great investments when there is inflation. They’re not great when there’s deflation.
Therefore, while I believe they are good investments for me, they’re not good investments for everyone—especially people who are still learning about the economy and investing who may not be able to react quickly to changing economic conditions.
At the end of the day, what I’ve been preaching all along—invest for cash flow—is the safest and soundest strategy that will serve you well in an inflationary economy. It’s a sure way to grow richer.