One of the great benefits of owning investment properties is that it gives you a hedge against inflation. To understand this better, let’s discuss some of the traditional ways investors attempt to grow their asset portfolios to keep up with (and beat) inflation.
Inflation is an increase in prices and therefore a decrease in the purchasing power of money. Essentially you must pay more money to purchase goods or services than before. For example, back in the day, a well know taco joint sold crispy tacos for $0.69 a piece, today you must pay $1.09 for that same taco. So how can you, as a hard working consumer, raise your purchasing power? How do you plan for retirement, knowing that a dollar today will not be worth a dollar tomorrow?
There are three ways to protect against inflation:
- The Safe way
- The Risky way
- The Smart way
The Safe way
Utilize Capital Preservation – The main goal of this strategy is to preserve capital and prevent loss in an individual’s portfolio, especially those nearing retirement, since they rely on this income to cover living expenses. Because retirees have a limited amount of time in which to recoup any losses if the market experiences a downfall, this strategy necessitates investments in the safest short-term investments available. Such investments are Treasury bills, CD’s (certificates of deposit), bond securities such as I-bonds and TIPS and Money Market Accounts. The main idea behind this thinking is that because they are government back securities they should keep pace with inflation AND the money is in a FDIC-protected institution.
The Risky way
Stocks, Commodities and Currencies –The main goal of this strategy is income potential rather than income security, which dials down to making lots more money, however, a higher reward comes with higher risk (potentially).
The lesser of the risky stocks are stock dividends. When a corporation earns a profit, that money can either be re-invested in the business or it can be distributed to shareholders. Many corporations retain a portion of their earnings and pay the remainder as a dividend. One point to consider with this stock is that not only do you receive a check for your portion of the dividend reimbursement but as the company’s profits raise so too does the stock in which you are invested; therefore potentially providing you with two income streams! Keep in mind that not every company issues dividend checks; instead they may use the cash dividend to purchase additional shares of company stock for the shareholder. The risky part comes when a company begins either losing money or shareholder confidence, when this happens the stock price and all its worth will be up in smoke.
Riskier investment strategies are commodities and currencies. Commodities are tangible items such as wheat, oil or copper; they are priced universally without concern to who produced said item and fluctuate daily based on global supply and demand, which is why they are considered risky.
Currencies work just like commodities but are based on gold and silver and like commodities are very risky. The price of these metals can drop at any given time and must be watched daily. If you have little to no knowledge about this type of investing, use caution!
The Smart way
Real Estate – This strategy offers the best of the above strategies without their risk.
A home can provide a real hedge against inflation no matter what happens to the price in the future. Why? There are several reasons, but the two best are fixed rate mortgages and rental income! When an investment property is purchased, most investors use other people’s money; such as a bank; taking out a 30 year mortgage on the property. If the investor can, they will get a fixed rate mortgage because, when not refinanced, the payment will not change for the next 30 years. What makes a fixed rate mortgage even better to an investor is that once rented out, the investor can keep up with inflation simply through yearly rental increases. For example; an investor buys a property with a $550 per month mortgage payment but charges his renter $750 because similar houses in the neighborhood are rented out for this price. After all required expenses, including the mortgage, are paid for (by the renter) the investor has a nice little profit and to top it off, next year he can raise rent a few dollars per month because “inflation” requires it!
So an investor can:
- Purchase a property using very little of his own money
- Set up a 30 year fixed mortgage
- Get a renter to pay “market” rent which will pay the mortgage, all expenses and when done correctly give the investor a monthly pay check
and finally the best part…
- Every year the investor may increase the rental prices thereby insuring that he is covered for inflation.
Of course like everything else in life there is a down side, even in real estate. In order to be successful you must know what you are doing. Don’t go out and buy the first house you see and then call yourself an Investor. Professional Real Estate investors deal with tenant turnover, vacancy, vandalism, maintenance, repairs and 2am plumbing issues that NO ONE wants to deal with at 11am much less when everyone else is tucked away in their cozy beds! As the Boy Scouts motto says: “Be prepared.” Success comes not thru blind faith and luck but through hard work and lots of failure!
Sometimes we as investors need a little help. Perhaps you need help finding decent properties with low turnover; maybe you need a property management company that actually works from an investor’s point of view or maybe you need background checks that actually ensure you are getting the most qualified applicants.
At Memphis Turnkey we mitigate the risks of owning rental properties by focusing on “better properties” in “better areas” making “better investments”. When you buy a property, you’re investing in a neighborhood, city, street and area; for a long period of time, that’s why location matters! The real secret to a well-performing long term asset is tenant retention, PERIOD. Turnover kills profits and properties, because you’ll spend just as much time rehabbing and fixing as you do finding another “quality” tenant. For that reason, we target better properties because “it’s hard to put good people into bad houses”.
Source: Hedging Against Inflation. Free from Broke.com