Breaking Down How Inflation Works With Your Investment Portfolio

If you have lived long enough, then you’ll know that inflation is one of those slow poisons that reduce the worth or value of your investment.

If you have lived long enough, then you’ll know that inflation is one of those slow poisons that reduce the worth or value of your investment. Inflation is simply the sustained or consistent increase in the general price level of goods and services in an economy over a period of time.

The average Inflation rate for Nigeria over a period of 10 years is 11.8%. In other words, if you save 1 million Naira, the value of your money in just ten years will be N882,000. This goes to show you that cash is risky as it is exposed to short-term inflationary issues.

One of the easiest ways to mitigate this risk is to diversify your investment portfolio across industries:

In truth, inflation cannot be totally eliminated. However, it can be reduced to a considerable level by diversifying portfolio by investing in companies that operate in different sectors and are inversely correlated. This is also great because sometimes, inflation has more impact in some sectors than the others depending on the policy that led to the inflation.

Another way is through foreign investments:

Remember the mild recession we had a few years ago? Those who had dollar denominated investments smiled to the bank at the detriment of those who did not. An alternative way for an investor to mitigate inflation risk is through foreign investments or sales and purchases of foreign exchange currencies.

Certain economies are indeed more stable than ours as a result of the strength of their economy. Holding short-term bonds denominated in foreign currencies with stable inflation and real interest rates is a way to protect investments against inflation.

Real Estate Investments:

There are situations where inflation has its advantages and one of such is the appreciation of real estate. On average, property values appreciate between 2% and 4% annually. In places like Ajah, Lagos, appreciation rates could range from 6% to 10%.

As such, if instead of keeping cash, you purchase a building for 1 million Naira, assuming an annual appreciation of 6%, you’d have a property valued at an increased capital gain of 60,000 Naira in just one year.

The essence of this is just to show that inflation can be curbed with an optimal allocation of your investment portfolio. Whether it is in a different class of asset, in a different country, or across other industries.

The question the lies in determining the optimal diversified allocation for hedging inflation risk. In other words, what percentage of your portfolio should be invested in foreign currencies, different industries or real estate?

This is left for you as the investor to determine, based on your investment mandate – objective, risk threshold, time etc.

Written by Lawretta Egba