You are bombarded with fear-inducing headlines on the daily about markets and the economy. Although we are in an ever-changing economic landscape, you can take control through education. Once you understand the terms and trends, you are equipped to make data-based decisions rather than ones based on fear.

In this blog, we will delve into what inflation is, give an example of how inflation impacts a money market account, and give you an understanding of how inflation relates to our high-interest rate environment. Finally, we will outline what this all means for passive investors.

What is Inflation?

When people hear ‘inflation’, they may automatically think it’s a bad thing. But it’s a common occurrence in economic cycles. It’s when inflation gets too high or out of control that it becomes problematic.

We are going to start out with a basic definition of inflation. Technically speaking, inflation is the rate at which the general level of prices for goods and services rises over a specific period. You can track inflation on a monthly or annual basis. An increase in inflation erodes your purchasing power as a consumer. $20 in 2023 is not the same as $20 in 1953. You can thank inflation.

The U.S. inflation rate in 2022 was a whopping 8%; projected annual inflation for 2023 is 4.5% (Statista). Inflation impacts everyone. Many educated investors benefit from it, and some people are hurt by it. While we can’t change the overall economic landscape, we can change how we navigate through it. Strategies to mitigate the risk of inflation are personal. It depends on your individual financial goals, risk tolerance, and current financial situation.

Annual Inflation Rates

What impact has inflation had over the past few years? Inflation peaked in June 2022 at about 9.1%. The annual inflation rates in the US from 2018 to 2022 were

‘18 2.4% 

‘19 1.8%

‘20 1.2%

‘21 4.7%

‘22 8%

(source: IMF via Statista)

How Inflation Impacts You

Example: Money Market Accounts

If you have money in a money market account making 4.5% right now, I have some not-so-good news for you. Inflation over the last 12 months (June 22–23) has averaged 7%. At 7% inflation, 4.5% in a money market account is making you -2.5%. You are still losing to inflation. These accounts just make us feel better about losing money.

Inflation for June 2023 was at 3%, so things are looking up. But, as inflation cools and the Fed starts bringing down their target (nobody knows when), money market accounts will move down in coordination with the Fed moving down. In short, your 4.5% is a short-term band-aid (and not the most effective band-aid if your goal is to outpace inflation).

Understanding Our High-Interest Rate Environment

Inflation peaked in June 2022 at 9.1% and cooled down to 3.7% as of August 2023. This was achieved in part through the Fed cranking up interest rates to cool inflation through quantitative tightening (QT). QT is a fancy way of saying the Fed made money more expensive to borrow. When money is more expensive to borrow, fewer people will engage in business activities that require borrowing money. Once the Fed feels like they’ve hit their targets for unemployment and inflation, they will begin to lower rates (i.e., quantitative easing).

You know QE is likely taking place when mortgage rates begin to drop. Once you learn about this pattern, it’s fairly easy to spot! If you keep an eye on inflation, it will be hard for you to be surprised. Never has there been a decline in inflation without a decline in rates following. As inflation eases, the Fed will lower rates; if inflation goes up, they can raise rates to discourage borrowing. Rinse and repeat!

What does this all mean for Passive Investors?

Investors, and especially passive investors, need to be aware of inflation and take steps to protect their wealth and their income from the erosive effects of inflation.

If you are a passive investor, you rely on your investments to generate income. Since you’re not actively working for this income, you need to be especially mindful of how inflation can erode the purchasing power of your money. If you invest in real estate, it can help you mitigate the erosive impact of inflation. How is this possible?

Real estate can help hedge against inflation because, historically, real estate values have tended to rise over the long term. When you own real estate or are a passive investor in real estate, you have an asset that can appreciate and keep pace with, or even outpace, inflation. Think of the way home prices skyrocketed into 2022 after the pandemic due, in part, to inflation. Your house is probably worth a lot more than it was just five years ago! A similar rise in the value of commercial properties also took place.

Not only can real estate potentially appreciate in value, but it can also provide passive investors with a source of income through rental income. That rental income will increase over time and often rise during times of inflation as a second way to help you hedge against inflation.

Here’s the key: buy on the downward slope of inflation (which is where we are right now). Distress in the market is a strong indicator to the savvy real estate investor and the savvy passive investor that it’s a good time to get into properties at a relative discount compared to what they will be worth in the long run!

What are the Benefits of Investing in Real estate?

Investing in real estate can help protect you against inflation due to its potential to increase in value and rental rates. What are some of the other benefits? Here are four:

1. Control:

   One key benefit of real estate in an inflationary environment is that you have control over what properties you choose to invest in. As a limited partner, you have a level of control that you don’t necessarily have with some other investments like stocks and bonds. This control can allow you to adapt to changing economic conditions and protect your investment from the negative effects of inflation. You can balance your investments between stable cash-flowing properties and those that have a bit more risk!

2. Leverage:

   Commercial properties can be purchased using financing (debt). Properly placed debt can actually work in your favor as an investor because inflation erodes the value of the debt you owe, making it easier to repay that debt over time. When you combine the potential for property appreciation, rental income, and the benefits of leverage, real estate can be a strong choice if you are looking to protect and grow your wealth in an inflationary environment.

3. Tax Advantages:

   Real estate provides tax advantages that can further enhance your returns as a passive investor. Tax benefits and depreciation can help mitigate the impact of taxes on your investment income. As an investor in a syndication, you can deduct passive losses against your passive income!

4. Diversification:

   Finally, it’s important to keep in mind that while inflation can erode the purchasing power of your dollars, it doesn’t mean that you should avoid holding any cash at all. Cash still plays a role in a well-rounded financial strategy. Cash provides liquidity and flexibility, and it’s important to have some cash on hand for emergencies and opportunities. The key is to strike a balance between holding cash and allocating your capital into assets like real estate that can help you preserve and grow your wealth over time.

What Can You Do as an Agent Who Invests?

1.  Get Educated:

   As much as you can, get smart and educated. You can’t control everything going on around you, but you can control your knowledge, and that can’t be taken away from you. An easy place to start is by monitoring inflation on a monthly basis. Many headlines floating around are meant to take advantage of fear and stir up your emotions. Don’t let them take advantage of you or steal your opportunity to create a better financial future for yourself and your family. Statisa (statista.com) is an excellent resource for drama-free data, and it’s free.

2. Challenge What You Know:

   A money market account making you 5% sounds like a pretty low-risk, no-brainer way to stash your cash. Maybe it is; we can’t and won’t tell you what to do. But you have to look deeper. Even just factoring in inflation (let alone opportunity cost), it’s not as much of a slam-dunk as it looked on the surface. Apply that same curiosity and healthy skepticism to other areas of your portfolio. Perhaps the narratives we’ve all been told aren’t as sound as we’ve been made to believe when it comes to our money.

3. Invest in Hard Assets:

   Consider investing in hard assets through a trusted general partner and operator. We obviously live and breathe real estate, but that doesn’t mean you need to be a landlord. There are ways to passively invest in real estate that allow you to enjoy many of the benefits without the hands-on management involved in active ownership. Of course, seek the advice of your own professional counsel, but there are tons of ways to get in on the real estate game while still keeping your current job and layering it on as a piece of your financial freedom puzzle.

Conclusion 

One of the takeaways from this discussion is that being informed and educated about financial matters is crucial, especially in an economic environment that’s subject to changes and uncertainties.

Knowledge is power when it comes to financial decision-making. And that’s why we encourage passive investors to seek out information, do their research, and work with trusted advisors who can help them navigate the complexities of investing in an inflationary environment.

When you have the knowledge and the right strategies in place, you can position yourself to not only protect your wealth from the erosive effects of inflation but also thrive and generate passive income in any economic climate.