Ask Chuck: Understanding Inflation/Deflation

Dear Chuck,

I’m new to investing and don’t really understand the ramifications of inflation and deflation. I would like to position myself to minimize loss regardless of what happens. Any tips?

Novice Investor 

Dear Novice Investor, 

I am not a professional investment advisor but can give you some Biblical financial principles that will help you get started on a solid foundation. 

1. Investing involves the risk of losing money. Be sure you have an emergency savings account in place before investing money. Don’t invest any money that you cannot afford to lose.

As my friend, Vince Birley says, if losing money makes you upset, maybe you need to give it away instead of investing it.

2. Avoid investing to simply acquire wealth. Motives matter to God.

“Do not toil to acquire wealth; be discerning enough to desist. When your eyes light on it, it is gone, for suddenly it sprouts wings, flying like an eagle toward heaven.”
(Proverbs 23:4-5 ESV)

It is better to start small and learn. Money quickly earned is also quickly lost.

Patience and humility are qualities that will help you.

3. Use your mind by reading, researching, and gaining knowledge on anything you are interested in so you can invest with wisdom. Far too many novice investors make guesses, take foolish risks, or follow advice from a friend that only tells you of all their success!

“By wisdom a house is built, and through understanding it is established; through knowledge its rooms are filled with rare and beautiful treasures.” (Proverbs 24:3-4 NIV)

4. Don’t try to time the market or predict the future.

No man knows what tomorrow will bring, so regardless of what all the get-rich-quick books may tell you, it is not a good idea to attempt to invest based on what someone has convinced you will happen to a stock, or gold or real estate or any other opportunity! Invest based upon your conviction that you believe the investment will perform well over time and you are willing to be patient even if it goes up and down in value.

Understanding Inflation and Deflation

Think of a balloon. Inflation causes it to expand. Deflation causes it to contract.  

The consumer price index (CPI) is the most common measure of inflation and is reported monthly by the Bureau of Labor Statistics. It averages a set basket of U.S. goods and services that includes 8 major groups: housing, food and beverages, medical care, recreation, apparel, transportation, education and communication, and others. When aggregate prices rise, the purchasing power of a dollar declines and vice versa. Central banks attempt to keep a balanced economy by conducting monetary policy which includes the setting of interest rates. However, the dollar can be impacted by things beyond our control.  

Inflation:

  • Availability of supplies drops
  • Prices of goods and services rise
  • Consumers willingly pay more for what things they want
  • Modest amount (2-3%) can encourage spending and investing

Hyperinflation:

  • Monthly prices exceed 50% over a period of time
  • May be accompanied by a sudden increase in the money supply.
  • Rare 

Deflation:

  • Too many goods are available so prices decrease
  • There is not enough money in circulation; inflation rate falls below zero percent
  • People spend less and begin to hoard money
  • Can lead to economic recession or depression

Remember to Diversify

Always remember Solomon’s advice to investors: diversify! Solomon advised diversity in Ecclesiastes 11:2, saying, “Give a portion to seven, or even to eight, for you know not what disaster may happen on earth.” 

Inflation hurts fixed-income investments like treasury notes and bonds. Stocks and real estate, though not risk-proof, offer returns that are not directly negated by inflation. Treasury Inflation-Protected Securities (TIPS) are low-risk investments that have a fixed interest rate. They are tied to the CPI so inflation will not wipe out their value. However, interest rates are very low. Investing in mutual funds or exchange-traded funds is another way to diversify.

Lisa Smith at Investopedia says: 

Inflation hedges include growth stocks, gold, and other commodities, and–for income-oriented investors–foreign bonds and Treasury Inflation-Protected Securities. Deflation hedges include investment-grade bonds, defensive stocks (those of consumer goods companies), dividend-paying stocks, and cash.

For a look at the past ten years, go to Diversification: The Only Free Lunch in Investing at Sound Mind Investing.  

Keep an Eternal Perspective

Adequate emergency funds and liquidity are important in a volatile environment, which experts are forecasting over the coming weeks and months. Certainly, the election is likely to cause market swings in either direction. 

Your dependence should ultimately lie in Christ. Do not trust in your assets, investments, or net worth. They are temporary and we are to keep an eternal perspective. We steward our finances to the best of our ability but do not put our hope in them. King David said: “Some trust in chariots and some in horses, but we trust in the name of the Lord our God.” (Psalm 20:7 ESV)

I hope these principles will guide you and help you as you get started.  

Originally published by the Christian Post, October 9, 2020. 

 

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