Crowdinvesting: How to protect Yourself from inflation!
It has long been no secret that life has become significantly more expensive in recent months: Starting with gasoline, energy costs to everyday goods such as food or visits to the cinema, the price increase is noticeable. According to the Federal Statistical Office, inflation even reached an all-time high in July 2022, when inflation reached 3.4%. Now the question arises how best to protect against the loss of value of money. More and more people are now trying to invest their money for profit. In this blog post you will learn how to protect your capital from inflation and how crowdinvesting can help you.
What actually is inflation?
Before we go into the individual ways to protect against inflation, we would like to briefly explain what inflation is in the first place. Inflation is the gradual loss of value of money and can also be referred to as “price increase“ or “devaluation of money“. As the name suggests, it indicates how much the prices of goods and services have risen over a given period of time. The higher prices rise, the more money loses value. There are different types of inflation:
Here, prices rise below 5% annually and, as a moderate variant, it is the predominant type of inflation in industrialized countries. It is good for the economy because it drives consumption and makes it possible to borrow money cheaply. The increase in prices is generally barely noticeable.
This type of inflation hurts the economy because prices rise faster than wages. People’s assets lose value and confidence in the currency declines, further fuelling inflation.
This is where prices rise uncontrollably and rapidly, with inflation at 50% or higher. The velocity of money in circulation is constantly increasing as people spend their money on goods as quickly as possible to stay ahead of further price increases.
It is the opposite of inflation, meaning that the general price level decreases. But this is not conducive to inflation either, because consumers thus postpone their purchases further and further. It is therefore in the interest of the state and central banks to avoid deflation.
So what does the record high inflation of 3.4% in July 2022 mean? It means that the same good cost 3.4% less a year earlier. So the price is up 3.4% from the year before. Where do you place this 3.4%? Economists consider 2% inflation to be healthy. However, the current value deviates from this. And where does this price increase come from now? Let’s look at it together.
What are the causes of inflation?
Before we go into the current causes of the current inflation, let’s first clarify the three general causes of inflation, here we have money supply induced inflation, demand induced inflation and supply induced inflation.
Money supply inflation:
In this form, states or central banks increase the money supply by printing new money.
This is when the demand of certain goods is greater than the supply. Thus, when demand increases and production remains the same, the prices of goods rise.
The price increase here is triggered by supply. For example, if a company increases the costs of certain goods and thus passes them on to consumers, the price will also rise as a result. In this case, we also speak of cost pressure inflation. Another possibility would be if companies increase prices without increasing costs in order to maximize profits.
Now we know the general causes of inflation, but how did the current demonetization in Europe come about? One driving factor is the war in Ukraine. Fueled by supply bottlenecks due to the Corona crisis, inflation rose substantially. Significant price increases in upstream economic sectors also contributed to this. As a result, the prices of energy products rose, as did those of other goods such as food.
It is also important to mention the key interest rate, which controls inflation on the government side. If the key interest rate is lowered, the banks borrow more money, whereby the money supply and thus also the inflation rate increase. If the key interest rate is increased, banks borrow less money from the central bank. So, in turn, the growth of the money supply decreases, slowing inflation.
Now that the types, causes and role of central banks in inflation are known, let’s find out how people can now protect themselves from demonetization.
How to protect your money from inflation
In principle, inflation should be taken into account in any investment, because it is a natural driver of the monetary system. Of course, the inflation rate does not stay the same, in some years it is higher, in some it is lower. So make sure that the interest or return on your investment actually exceeds – or at least offsets – inflation. If you want to achieve value preservation, the investment must at least generate a return equal to the inflation rate. If you want to make a profit, the return on the investment must exceed the rate of inflation. The effective return is therefore the difference between the return minus inflation. But what is the best way to approach this issue as an investor?
In principle, when investing – regardless of inflation – it is important to spread or diversify the risk. But especially in uncertain times of wars and inflation this point has to be considered. If you want to protect your money, it is best to spread your capital over many investments and portfolios to avoid risk clusters. It is also important to mention here that traditional savings products such as the savings book hardly to low interest is paid out. If you leave your capital in a savings account, you will hardly receive any interest and inflation will devalue the money. But which financial products are suitable for protection against inflation?
Shares and ETFs
Shares belong to tangible assets, because behind them are companies with associated real values (factory buildings, machines, personnel, etc.). Shares are well suited for inflation protection, because when the money supply rises, the share prices also rise. If the company manages to pass on the cost increases caused by inflation, shareholders benefit from inflation. In the past, the majority of companies were able to pass on rising prices to consumers. As a result, companies have at least been able to keep profits stable. For this reason, it is also important to invest in equities in as broadly diversified a manner as possible. Exchange traded funds (ETFs / index funds) are one possibility.
Government bonds: With government bonds, investors lend their money to the government for a term of between five and 30 years. In return, they receive interest based on the level of consumer prices. The accumulation, but also loss of wealth, is rather not possible, because the state normally pays back the money at the end of the term, but rather does not pay interest above the level of inflation.
Corporate bonds: Many companies no longer rely solely on banks for their financing and therefore look for additional sources of financing via the stock exchange. Through a bond, you enable a company to obtain financing and at the same time receive interest on it. However, the creditworthiness of a company must be taken into account, because only the future solvency of the company can guarantee the interest and redemption payments. The higher the risk, the higher the interest rates usually are. If the interest on corporate bonds is above the rate of inflation, protection against the depreciation of money is provided. However, when inflation rises, bond prices normally fall. As a protection against inflation, they are therefore ideal only to a limited extent.
Precious metals such as gold are a tried-and-tested crisis protection, and especially when there is concern about the stability of the monetary system, people like to fall back on them, causing demand and thus the price of gold to rise. One disadvantage, however, is that no interest or dividends are received in return, and investors have to wait a long time to get their investment back. The sometimes high fluctuations of the market price and the storage costs are also problematic. Precious metals such as gold, silver and platinum are therefore rather suitable only as a long-term investment and are seen as a crisis currency. Ideally, one should invest about 5 to 10% of the portfolio in precious metals.
Houses, apartments and land are among the classics as tangible assets to protect against inflation. A real estate investment is profitable if the property is sold during a period of high inflation. In this case, you get a higher price for it than you originally paid. If the property is sublet, the buyer can also pass on the costs to the tenant. However, as inflation increases, so do the ongoing costs of maintaining the property. If rents do not rise in proportion to the costs, the landlord makes a loss.
As a long-term inflation hedge, therefore, real estate is certainly suitable as a tangible asset, but a deficit can arise in the process – for example, if the financing and management costs exceed current income as a result of inflation.
Through crowdinvesting, even small investors can protect themselves against inflation. With crowdinvesting, individual investors (the “crowd“) participate in the financing of companies and can benefit from strong potential returns. You can invest in startups, SMEs as well as real estate projects. With an equity investment, you participate in the growth of investment objects that you put together individually. In return, you receive basic interest in the event of success as well as a share in the value of the company in the case of startups.
Investors receive interest and principal payments at regular intervals. The advantage here is the chance of high returns that far exceed usual interest rates for loans. In terms of risk profile, they are similar to equities and corporate bonds. However, in the event of extremely high inflation, interest rates must also exceed the rate of inflation in order to be profitable.