Many businesses have experienced a challenging past 12 months. The pandemic and resulting quarantine measures may be starting to ease, but companies still need to face the prospect of high inflation on the horizon. While inflation was on a downward trend previously, the Federal Reserve just raised its estimate of average inflation this year from 3.4% to 4.2%.
An increase in inflation has a number of effects on the economy. First and foremost, it erodes purchasing power as the cost of retail goods and services increase. It can also raise the cost of borrowing as interest rates increase due to increased risk. Inflation increases can also fuel further inflation, creating a feedback loop. As people spend more quickly to reduce the time holding depreciating currency, the supply of money is greater than the demand — so the purchasing power of the currency falls at an even faster rate.
However, not all of the effects of inflation are negative. Inflation does encourage spending, and with the prospect of declining purchasing power, the typical response is to buy now rather than waiting. Since cash is likely to lose value, it is better to do your shopping now, stocking up on items that are not likely to lose value. Consumers are likely to fill their freezer, top up the gas tanks, and buy new clothing early for their growing children.
Fortunately, there are some measures you can take in the face of increasing inflation.
While having liquid assets on hand to weather any financial storm is a good idea, when inflation is high, the buying power of cash is reduced. Therefore, having an abundance of cash on hand is not really a good idea.
While reallocating a percentage of your portfolio into stocks is sensible, it may be a better idea to use surplus cash to purchase equipment or other resources that can not only provide value for your investment, but also help you to further strengthen your company operations.
Before making any snap decisions about what to do with your cash, you will need to consider the specific circumstances of your company. Look at the rate of inflation and the rates on offer for bonds and investment accounts. While you may need to tie up your funds for a set period, you may be able to combat the increase in inflation.
If there are no appropriate bonds or accounts, you may need to reduce the liquidity of your funds by investing into stocks. Just be sure to consider the fees associated with these types of transactions.
Look at real estate
Property can often act as a good hedge against inflation. With the prospect that inflation is coming, your company may benefit from real estate investment. If you have the financial ability, purchasing a property can be more cost effective than facing increasing rent costs for your operation.
If this is not possible, you may want to reduce your exposure by investing in other types of real estate. REITs (Real Estate Investment Trusts) allow individuals, companies and other investors to create portfolios of residential, commercial or industrial properties.
This can provide your company with an additional income through leases and rents, enjoying higher yields compared to investing in US Treasury bonds. Properties are not likely to be affected when inflation rates start to rise as the operating costs will largely remain unchanged.
However, you do need to consider that real estate and REITs tend to be illiquid. You will not be able to access your funds if you find that you have a financial emergency.
Other investments that can be good against inflation (but a bit more risky) are gold and commodities in general — whether it’s a gold mining stocks, purchasing physical gold or investing in gold ETFs and gold mutual funds. In addition, many people claim that investing in crypto is a great hedge as well. However, crypto coins are super volatile making that risk very high.
There are a number of major global economies that do not fluctuate in tandem with the U.S. market. Examples of these economies include Australia, South Korea and Italy. Diversifying into these markets or similar countries may help to bolster your company against the domestic economic cycles.
This is the reason why many international companies choose to set up operations overseas. This allows them to not allow U.S. fluctuations to impact operations since they are dealing in a local currency.
While this may not be possible for many companies, it may be possible for your company to make some changes and improve international diversity. For example, you could invest in foreign bonds, source assembled components rather than buying raw materials, or negotiate deals for fixed rates in U.S. dollars. This will allow you to continue paying a set amount in dollars, regardless of how the currency fluctuates.
Finally, one of the most effective ways to address increasing inflation is to assess your expenses. Take a serious look at costs and operating expenses. You may be able to identify areas where you can make savings and create a buffer that can absorb any increasing costs.
Consider all aspects of your operating costs. Is it possible to source raw materials elsewhere for a better deal? Can you set up a contract with a fixed rate to protect against increases in the near future? Is there any tolerance for adjusting your wages bill? Will you be able to provide a cost of living increase for your staff?
Being prepared is the best defense against the potential for rising costs and inflation. It is far better to assess your budget and operating costs now rather than when you are under pressure to make cuts when prices start to increase.
Some industries have been harder hit than others, but the pandemic has affected retail, tourism, hospitality, restaurants and housing in particular. On the other hand, some industries have seen an uptake throughout 2020. This highlights that each company will react differently to changing economic conditions. Therefore, it is important to realize that increasing inflation will not affect every company in the same way. So, you need to consider how inflation will impact your company.
By taking a proactive approach, you can reduce the potential implications of increasing inflation, so that you can continue operating with the minimum of disruption. This will allow you to weather the possible storm and come out of the other side as a successful operation.