When we think about inflation, we always tend to first think of the negatives such as rising food costs, gas prices, etc., but what most of us don’t realize a lot of times is the benefit of inflation if we are positioned correctly to benefit from it.
The effect of inflation ranges over a spectrum from quickly destroying your finances and reducing your cash purchasing power all the way to potentially helping you increase your net worth significantly, if you are doing the right things.
Let’s Break That Down:
If you are sitting on cash during inflationary times, your purchasing power goes down by the day. The dollar has lost more than 92% of it’s value since 1950, even before the US got off the gold standard in 1971. Inflation in the economy is not only normal, but it is absolutely encouraged by the government as it incentivizes people to spend money and stimulate the economy.
If we had zero or negative inflation, people would be more incentivized to hold on to their money as things would get cheaper with time, not more expensive.
On the other hand, with a normal 2-3% inflation, people are encouraged to spend their money as things would get more expensive with time.
The inflation rate in April of 2022 was at a record high of 8.5%, way above the target of 2-3% a year that we’ve been accustomed to. The problem with holding cash in situations like this is that you would be losing a very significant percentage of your money month over month.
Assets, especially real assets such as Real Estate, have historically performed very well during inflationary periods as investors get out of cash positions and move into assets that have better yields.
A normal or high level of inflation actually help the price of assets go up, and as more people try to deploy their cash to reduce their exposure to negative inflationary effects on cash, assets tend to shoot up in value as there is more cash and less assets to be owned.
Leverage & Debt:
Whenever you think of inflation, it’s important to realize the effects it has on debts both in Real Estate and everyday debt such as credit cards. If you owe $100,000 to the bank, and there is a 5% inflation rate, the value of that $100,000 loan that you have is going down in value by the day.
Sure, the amount isn’t changing unless you pay it off, but the purchasing power of that loan amount is going down, just as the value of cash is going down with it.
This is how inflation helps the US economy. It reduces the value of the trillions of dollars that we owe in debt. You can use that same concept to reduce the value of your debt. That is one of the reasons why I borrow millions of dollars to buy Real Estate. As the value of those assets is going up, and as they are producing cash flow, the debt I borrowed to buy the assets is getting less and less valuable with time.
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