Inflation Hedge

Posted in Finance, Accounting and Economics Terms, Total Reads: 377

Definition: Inflation Hedge

Inflation hedge is an investment that will provide protection against inflation risk or decreased value of currency. It involves investing in assets that are expected to increase in value over a specific period of time e.g. gold, oil, real-estate etc.

Inflation decreases the value of money over a period of time such that the return that we get from the investment would less than its real worth when invested. For e.g. If Mr. A has 100$, and he invests it in a bond that gives a return of 5% after a year. But if the rate of inflation is 6% then the investment in bond is not worth, as it gives a lower return when compared to the inflation. So initially Mr. A would have been able to purchase goods worth 100$ but after one year, with the returns from his investment i.e. $105 he would be able to purchase goods only worth 99.0566$ (105/106).

So hedging against inflation helps reduce this risk. Most hard assets such as gold, oil and commercial real-estate are inflation hedging tools. They also have a negative correlation to stocks and bonds. At times when there is high inflation, stocks and bonds suffer but hard assets tend to outperform the inflation.

For e.g. In USA, between 1970 and 1981, the S&P 500 index increased by 20% whereas there was 100% increase in oil prices and 550% increase in real estate prices and around 500% increase in gold price.

Above is the graph showing the historic price of gold from 1970 to 2015.


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