Mutual Funds: Beat Inflation With Smart Investing

Inflation is a growing concern for investors, as it erodes the purchasing power of an investor's portfolio over time. The average annual inflation rate in the US since 1960 has been 3.7%, and while this rate masks a lot of variances, it is a useful benchmark for investors. To beat inflation, investments will need to earn at least this amount to keep from losing ground.

Mutual funds are one of the best ways to combat inflation. They are a type of investment that pools money from different investors and then uses this money to invest in financial markets. Mutual funds can invest in different asset classes depending on the fund's theme, and they are managed by experienced professionals. While there are many types of mutual funds, equity mutual funds have been shown to generate returns that beat inflation and are therefore an important ingredient of an investor's portfolio.

Equity mutual funds have given an average return of 13-15% in the last few years, compared to other popular options like bank deposits, PPF accounts or gold, which have returned 1-3%. The returns from equity mutual funds are also tax-free if held for more than a year, giving them higher average returns. Diversified equity funds invest in a wide range of companies, and if the country's GDP grows, these companies will grow too, which is reflected in higher share prices and consequently higher returns for investors.

In addition to equity mutual funds, there are other ways to beat inflation, including investing in gold, stocks, real estate, and Treasury Inflation-Protected Securities (TIPS).

Mutual funds vs. cash savings

When it comes to investing, risk and reward go hand in hand. While cash savings are generally considered a safe option, they may not always be the best way to grow your money, especially in the face of inflation.

Mutual funds are a type of investment where your money is pooled with other investors' funds and invested in stocks, bonds, and other securities. Each investor owns a certain number of shares, which can be redeemed at any time. Mutual funds offer the potential for higher returns but come with higher risk. On the other hand, cash savings accounts are generally very low-risk and offer stable but lower returns.

Mutual Funds

Mutual funds can be an effective way to combat inflation, which erodes the value of your money over time. By investing in a diverse range of assets, such as Treasury inflation-protected securities (TIPS), commodities, real estate, and stocks, you can stay ahead of rising prices.

For example, Vanguard's Treasury Inflation-Protected Securities Investor (VIPSX) is a mutual fund that invests in TIPS, which are bonds indexed to inflation. As inflation increases, the principal value of TIPS also adjusts, helping to protect your investment.

Additionally, mutual funds offer the advantage of professional management, as fund managers make investment decisions on your behalf. This can be especially beneficial for those who don't have the time or expertise to actively manage their investments.

However, it's important to remember that mutual funds come with various fees, such as expense ratios and management fees, which can eat into your returns.

Cash Savings

Cash savings accounts, including traditional savings accounts and money market accounts (MMAs), are considered very low-risk options for storing your money. They are typically offered by banks or credit unions and are FDIC-insured up to $250,000, providing a level of security for your funds.

While cash savings accounts offer stability and easy access to your money, their returns often fail to keep up with inflation. For example, if you have a savings account with a 1% interest rate and an inflation rate of 3%, your money is losing value by 2% each year.

Additionally, savings accounts may come with monthly maintenance fees, minimum balance requirements, and withdrawal limitations, which can further reduce your overall returns.

While cash savings accounts provide stability and easy access to your funds, mutual funds offer the potential for higher returns to combat inflation. However, it's important to remember that mutual funds come with higher risk and fees that can impact your overall returns. Ultimately, the decision between mutual funds and cash savings depends on your financial goals, risk tolerance, and time horizon.

Gold as an investment

Gold has been a popular tool for storing wealth throughout human history and it continues to be a popular investment choice. It is portable, easy to trade, and has enduring value.

Advantages of Investing in Gold

Gold can be a safe-haven asset during market downturns, protecting savings in the event of a market crash. For example, the price of gold increased by over 100% between 2008 and 2012, during the financial crisis. Gold is also seen as a hedge against inflation and a store of value through market volatility.

Gold can be a good investment option during periods of extreme volatility in the stock market, currency instability, or civil unrest. It can also be used to diversify a portfolio, as it is not correlated to stocks, bonds, or real estate.

Disadvantages of Investing in Gold

Gold does not generate income; investors only make money if the price of gold increases. There are also extra costs associated with owning and storing gold, such as transportation and insurance. Physical gold, such as bullion or jewellery, may be difficult to sell quickly and may not bring a high resale value.

Gold is also highly volatile and past performance is not a reliable indicator of future returns. The price of gold can be influenced by political events, such as wars, national elections, and changes in government policies.

Ways to Invest in Gold

There are several ways to invest in gold, each with its own advantages and disadvantages.

• Physical gold: This includes gold coins, bullion, or jewellery. Physical gold requires secure storage and insurance and may be difficult to sell quickly.
• Gold stocks and ETFs: Investing in gold stocks, mutual funds, or exchange-traded funds (ETFs) is a more efficient option with lower transaction costs. Gold mining and refining company shares tend to deliver better returns as gold prices increase.
• Gold certificates: These represent ownership of a specific amount of gold stored by the issuer and allow investors to benefit from price movements without managing the physical asset.

Tips for Investing in Gold

• Consider gold stocks, ETFs, and mutual funds for better liquidity.
• Stick to standardized gold investments, such as gold bars or coins produced by governments, to ensure you know what you are buying.
• Buy from reputable dealers to reduce the risk of overpaying or being cheated.
• Use a precious metal IRA for tax savings, but be aware of potential fraud and hidden fees.
• Consult with a financial advisor to get an unbiased opinion about gold as an investment.

Gold can be a prudent choice for investors seeking to diversify their portfolios, hedge against inflation, and protect their assets during economic uncertainty. However, it may not offer high returns, and there are better and worse times to invest. Investors should consider their risk tolerance, financial goals, and market outlook before investing in gold.

Real estate investment trusts (REITs)

REITs are structured as corporations and are typically not taxed at the entity level, which helps investors avoid double taxation on dividends. They are required to pay out 90% of their taxable income to shareholders as dividends. Due to this structure, they tend to pay out higher dividends than equities or many fixed-income investments.

REITs can be an effective hedge against rising inflation rates. They often have agreements that allow them to raise rents in tandem with inflation, particularly those with commercial holdings. Additionally, the underlying properties and rents of REITs tend to appreciate in value alongside consumer prices, which can help them improve their dividends at a faster rate than inflation.

There are two main types of REITs: Equity and Mortgage. Equity REITs own and manage properties and collect payments from tenants, while Mortgage REITs invest in mortgages and derive their income from interest payments.

When investing in REITs, it is important to consider the benefits and risks. REITs offer higher dividend yields, accessibility, and diversification benefits. However, they are subject to real estate market risks, interest rate risks, occupancy rate risks, and geographic risks, among others.

For those considering investing in REITs, it is recommended to consult a financial advisor and do thorough research to understand the potential benefits and risks involved.

Treasury Inflation-Protected Securities (TIPS)

TIPS are indexed to an inflationary gauge, such as the Consumer Price Index (CPI), which measures the pace of increasing prices in the US economy. When the CPI increases, the principal (or par value) of a TIPS bond increases, and when the CPI decreases, the principal decreases. This adjustment ensures that investors do not lose money due to inflation eating into their returns.

TIPS are sold for terms of 5, 10, or 30 years, and they pay a fixed rate of interest every six months until maturity. The interest payment amount varies because it is calculated based on the adjusted principal value of the bond. If the principal amount is adjusted higher over time due to rising prices, the interest payment will be higher. Conversely, if there is deflation and prices fall, the interest payment will be lower.

At maturity, investors receive either the inflation-adjusted principal or the original principal, whichever is greater. This means that investors are guaranteed to get back at least their original investment. TIPS can be purchased directly from the US government through the TreasuryDirect system, in $100 increments with a minimum investment of $100. They can also be bought through a bank or broker.

TIPS offer several advantages, including inflation protection, safety and stability (as they are backed by the US government), regular interest payments, potential for capital appreciation, tax advantages, diversification benefits, and market liquidity. However, there are also some disadvantages to consider, such as lower yields compared to other bonds, taxation on inflation adjustments, deflation risk, liquidity issues during times of financial crisis, and opportunity cost.

Overall, TIPS can be a valuable addition to an investment portfolio, particularly for conservative investors seeking capital preservation and those focused on generating a stable income stream, such as retirees.

Diversification of your portfolio

Diversification is a key battle cry for financial planners, fund managers, and investors alike. It is a management strategy that blends different investments in a single portfolio. The idea is that a variety of investments will yield higher returns and lower the risk.

• Spread the Wealth: Don't put all your money in one stock or sector. Create your own virtual mutual fund by investing in a handful of companies you know and trust. You can also invest in commodities, exchange-traded funds (ETFs), and real estate investment trusts (REITs).
• Consider Index or Bond Funds: Add index funds or fixed-income funds to your portfolio. These funds try to match the performance of broad indexes, so instead of investing in a specific sector, they reflect the value of the bond market. Index funds often have low fees, which means more money in your pocket.
• Keep Building Your Portfolio: Regularly add to your investments. If you have a substantial sum to invest, use dollar-cost averaging to smooth out the peaks and valleys created by market volatility. This strategy involves investing the same amount of money over time, buying more shares when prices are low and fewer when prices are high.
• Know When to Get Out: Stay current with your investments and any changes in market conditions. This will help you know when it's time to cut your losses and sell.
• Keep an Eye on Commissions: Understand what you are getting for the fees you are paying. Some firms charge monthly fees, while others charge per transaction. Be aware of any changes to your fees, as these can chip away at your bottom line.

When diversifying your portfolio, it is important to look for asset classes with low or negative correlations. This means that if one moves down, the other tends to counteract it. ETFs and mutual funds are easy ways to select these asset classes, but be aware of hidden costs and trading commissions.

• Gold: Gold is often seen as an "alternative currency", especially in countries where the native currency is losing value. It tends to hold its value and is a real, physical asset. However, gold is not a perfect hedge against inflation as it pays no yields.
• Commodities: Commodities have a unique relationship with inflation. As the price of a commodity rises, so does the price of the products that the commodity is used to produce. You can invest in commodities via ETFs such as the iShares S&P GSCI Commodity-Indexed Trust (GSG).
• 60/40 Stock/Bond Portfolio: This is a safe, traditional mix of stocks and bonds. You can invest in this type of portfolio through the Dimensional DFA Global Allocation 60/40 Portfolio (I) (DGSIX).
• Real Estate: Property prices and rental income tend to rise with inflation. You can gain exposure to real estate through REITs, which pay out dividends to investors. The Vanguard Real Estate ETF (VNQ) offers broad exposure to real estate with a low expense ratio.
• The Bloomberg Aggregate Bond Index: This index measures the US bond market and includes government, corporate, taxable, and municipal bonds. You can invest in this index through funds that replicate its performance, such as the iShares Core US Aggregate Bond ETF (AGG).

Frequently asked questions