Stocks4Docs aims to empower health care professionals on their personal journeys to creating wealth and every so often I like to return to the basics on the weekly podcast. This week I will do just that by demystifying the term inflation. Always in the news, inflation is a buzzword thrown about, but I’d specifically like to talk about how we should think about inflation as investors. I also want to address what we need to learn about inflation in the context of investing. Let’s start out by defining and examining a few key terms and relationships.
What is Inflation?
Inflation measures how much more money a set of goods or services has become over a period of time. Normal inflation is considered 2% or less. Inflation can also be discussed in other terms such as the Consumer Price Index (CPI). CPI measures the change in prices over time paid by urban consumers like you and me.
Inflation and Interest Rates
Interest Rates are set by the banks (and the US Federal Reserve). As interest rates go up, consumers tend to save more and then inflation goes down. When interest rates go down, people will borrow more money, use it, and inflation will go up. An example of this inverse relationship is the recent housing market. In this housing example, mortgage rates fell, and people bought homes. This led to home prices skyrocketing and in many markets these prices are at an all-time high.
Inflation and Investing
Although there are no hard or fast rules, after doing some research, it seems that there are some principles that tend to be true. Historically value stocks will perform well during inflation periods and growth stocks will take a downturn. And, overall, inflation is a hurdle for investors.
Investor Misery Index
The concept of real return on investment takes inflation into consideration. Warren Buffett goes a step further and talks about the concept of the Investor Misery Index (IMI). The IMI looks at the rate of inflation plus taxes that need to be considered in an investment. You need to overcome or compensate for taxes and inflation to make the gains you expect.
What does this mean for us as Investors?
Opportunities for investment do exist during periods of inflation. Look for companies that can keep their capital down but continue to forge ahead with business and those that can increase their prices early on without losing their customers. What companies can do that? Those with a strong moat, or durable and competitive advantage (check out podcast episode #4 for more details on value investing and moat). In addition to competitive advantage, commodities that you understand, good leadership, and fair price all come into play here as well. These value companies are the value stocks you should be researching when there is a high rate of inflation. And, during this time, you might be able to buy in at a good price!
Periods of high inflation can be a good time to get into the market by investing in value stocks. Is today the day you will make your move?
Listen to Podcast Episode #40 here https://stocks4docs.org/podcasts/ to get all the details on what you need to know about inflation.
Looking for more great content about investing, personal finance, and more? Keep tuning into the Stocks4Docs Podcast.