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What Is The Best Way To Hedge Against Inflation?
Inflation is screaming 😱 out of control. Many people who are very conservative have been saving money for years if not decades. What is the best way to invest money during periods of out of control Inflation?
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5 Replies
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Have you money parked in appreciating assets (aka cashflow)… Think of it this way: Inflation means the buying power of the dollar is going down. Appreciation means the value of an asset is going up… These two work hand-in-hand…
Here’s my personal list that I go buy in order of importance with examples
- Appreciating asset – Home Value going up AND you’re cash-flowing monthly
- Depreciating asset – Home Value going down BUT you’re cash-flowing monthly
- Appreciating property – Home Value going up BUT you’re breaking even on your expenses
- Appreciating liability – Home Value going up BUT you’re losing money monthly
- Depreciating property – Home Value going down AND you’re breaking even on your expenses
- Depreciating liability – Home Value going down AND you’re losing money monthly
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This reply was modified 1 year, 2 months ago by Nelson.
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Cash is the worst way of holding your assets in a high inflation economy. The stock market is too volatile. Real estate is the investment of choice in a unstable volatile economy with inflation out of control.
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The daunting challenge of navigating an investment in a high-inflation economy can be troublesome while opening many opportunities. Here are some of the best practices while considering to protect and potentially build wealth in a highly inflated economy:
Emphasize in Real Assets
Real Estate: Property valuations and rental income increase with time and inflation. It is worth looking into residential and commercial real estate, Real Estate Investment Trusts (REITs), and rental property investments.
Commodities: Holding commodities like gold, silver, etc., or oil protects investors from extreme inflation as they are considered inflation-proof investments.
Stocks and Equities
Equities: Stocks are a good long-term investment, as they do well in an inflationary economy. Businesses that are able to maintain their margins intact have the power to alter pricing based on cost increases.
Dividend Stocks: Focus on businesses with a history of regularly paying and increasing their dividends. These businesses will likely provide an aging investment and reliable income. Still, the income will be above average and timeless when inflation persists.
Inflation-Protected Securities
Treasury Inflation-Protected Securities (TIPS): These TIPS are literally US government bonds guaranteed to protect you from inflation. Government bonds ensure an enormous rate of return due to the appreciation of the investment made.
Commodities and Natural Resources Funds
Commodity ETFs: Investing in ETFs based on tradable commodities and natural resources would be ideal. Such investment opportunities allow access to and target asset classes that grow well in times of high inflation.
Loans or bonds with flexible interest payments are beneficial during inflation, as the payments increase when interest rates go up. Also, such bonds provide more returns in a growing rate scenario.
Quality Issue Bonds
An investment in bond markets can become overweight if short-duration government and corporate bonds are included, as they are less exposed to interest hikes than long-duration bonds.
Rollover
Using Asset Allocation Strategy: A well-diversified portfolio is a great way to stay protected from risk. Invest in various sectors, countries, or asset classes to lessen the impact of a single investment.
Non-traditional Investments
Bitcoin and other cryptocurrencies: Some cryptocurrencies, like Bitcoin, are used to guard against inflation, although they can be very unstable. Use these as part of a diversified portfolio, and keep them to a limited size.
Collectibles and Artwork: This can also act as a hedge. However, these can also be difficult markets to invest in as they require knowledge and can also be illiquid assets like antiques, artworks, and collectibles.
When investing in a high-inflation environment, the most important focus is protecting one’s purchasing power. Invest in real assets, equities with growth potential, and assets built to hedge against inflation. Given the complexity of the environment, holding a diversified and balanced portfolio would be essential. Always look at your risk appetite and investment objectives and talk to your financial adviser when in doubt.
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What are the tax implications of each investment strategy?
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Investing in high inflation can be tricky, especially in terms of taxes. This post will discuss the taxation aspect of various investment methods.
Real Estate
Capital Gains Tax: Making a profit on the sale of property may be subject to capital gains tax. The amount of tax will vary depending on the duration of ownership.
Depreciation: Rental properties are subject to depreciation, which lowers taxable income, although the sale of rental property will trigger a recapture tax.
1031 Exchange: Provisions allow one to reinvest in another property through a 1031 exchange to avoid paying taxes on gains earned from selling the original property.
Stocks and Equities
Capital Gains Tax: A tax will be imposed on selling stocks making a profit called the capital gains tax. The duration for which the stock has been held determines the governing rate for the tax. (Profits earned from stocks held for less than a year are classed as ordinary income, while after a year, profits are taxed at a lower level).
Qualified Dividends: There is a premium on qualified dividends paid out on stocks of 15-20% based on your earnings.
Loss Harvesting: If any losses occur, you can use them on other investments to lower overall tax returns.
TIPS
Interest Income: Interest earned on TIPS accounts is subject to federal taxation but not state or local taxes.
Inflation Adjustment: Any increase in the principal due to inflation is taxed during the year. Such an adjustment is made regardless of whether you choose to wait for maturity or sell the property.
Direct Investment, such as physical Commodities and Natural Resources, Collectibles Tax Rate: If you directly invest in physical commodities (like gold), any profit deriving from such investment can be subject to high-level taxation at the collectibles percent rate, which is 28%.
ETFs and Mutual Funds: Otherwise, the sale of them in the open market triggers taxation as capital gain, with all distributions subject to common income tax.
K-1 Forms: Some partnerships focused on commodities may require you to fill out a K-1 form, which impacts your tax.
Commodities: Floating Rate Bonds Interest income: Ordinary income is taxed on interest payments, and since that is greater than capital gains tax, all interest incurred falls in a higher rate band.
Capital Gains: If the property is sold at a profit, capital gains tax may be incurred on selling the profitable profit, depending on the holding period before the sale.
High-Yield Bonds Interest Income: Interest from bonds is similar to floating-rate bonds or other bonds, whereby interest income is treated as ordinary income tax.
State and Local Tax: Being a bondholder in high-tax states has a unique appeal, as some municipal bonds are exempt from federal and state taxes.
Diversification
Overall Tax Strategy: The tax implications of any given diversified portfolio depend on the specific investments made. It is important to manage taxes through asset location, i.e., investing tax-efficient funds in taxable accounts.
Alternative Investments
Cryptocurrencies: For tax purposes, cryptocurrency gains are categorized as capital gains and are deemed “realized” or incurred when the asset is sold, traded, exchanged, or used to purchase goods or services.
Art & Collectibles: In a developing world, gains arising from the disposal of collectibles will attract a 28% tax, just as with income from commodities.
In this case, the return on investment in each strategy is handled qualitatively, as the impact of taxes will vary and may influence your ultimate investment returns. By comprehending these issues, you know the decisions you must make to meet your investments and tax expectations. When considering investment strategies during high inflation, it’s important to understand the tax implications associated with each. Here’s a breakdown of the tax considerations for various investment strategies:
Real Estate
Capital Gains Tax: When selling a property for a profit, you may owe capital gains tax. The rate depends on how long you owned the property (short-term vs. long-term).
Depreciation: You can deduct depreciation on rental properties, reducing taxable income. However, this can lead to recapture taxes when you sell.
1031 Exchange: You may defer capital gains tax by reinvesting in another property through a 1031 exchange, allowing you to defer taxes on gains.
Stocks and Equities
Capital Gains Tax: Selling stocks at a profit incurs capital gains tax, with rates depending on the holding period (short-term gains are taxed as ordinary income, while long-term gains are typically lower).
Qualified Dividends: If you receive dividends from stocks, they may be taxed at a lower rate (15% or 20% for high earners) if classified as qualified dividends.
Loss Harvesting: To reduce tax liability, you can offset capital gains with capital losses.
Inflation-Protected Securities (TIPS)
Interest Income: The interest earned on TIPS is subject to federal income tax but exempt from state and local taxes.
Inflation Adjustment: Any increase in the principal due to inflation is taxable in the year it occurs, even though you don’t receive that adjustment until maturity or sale.
Commodities and Natural Resources Funds
Collectibles Tax Rate: If you invest directly in physical commodities (like gold), profits may be taxed at a higher collectibles rate of 28%.
ETFs and Mutual Funds: Generally taxed as capital gains when sold, and distributions are taxed as ordinary income.
K-1 Forms: Investing in certain commodity-focused partnerships may require you to file a K-1 form, which can complicate your tax situation.
Floating Rate Bonds
Interest Income: Interest payments are taxed as ordinary income, which can be higher than capital gains tax rates.
Capital Gains: If sold for a profit, gains may incur capital gains tax depending on the holding period.
High-Quality Bonds
Interest Income: Similar to floating rate bonds, interest from bonds is taxed as ordinary income.
State and Local Tax: Some municipal bonds may be exempt from federal and state/local taxes, making them attractive in high-tax states.
Diversification
Overall Tax Strategy: The tax implications depend on the specific investments included in the diversified portfolio. Managing taxes through asset location (placing tax-efficient investments in taxable accounts) is crucial.
Alternative Investments
Cryptocurrencies: Profits from cryptocurrencies are taxed as capital gains, and any transactions (including selling, trading, or using crypto for purchases) may trigger taxable events.
Art and Collectibles: Gains from the sale of collectibles are taxed at a 28% rate, similar to commodities.
The tax implications of each investment strategy can vary significantly, impacting your overall return. Understanding these implications allows you to make informed decisions that align with your financial goals and tax situation. It’s often beneficial to consult with a tax advisor or financial planner to optimize your investment strategy, considering tax considerations.
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