Robert Kiyosaki waving holding a copy of Rich Dad Poor Dad.

How You Can Profit From Inflation

The Rich Dad way of investing is your inflation insurance

A while back, I wrote about why the middle class is screwed. I shared how the rising cost of healthcare was causing traditionally financially comfortable folks to spend less and less on basic needs. Before that I wrote about the reason you feel (and are) poorer. I shared how the wages of the middle class have been largely stagnant. Some people have seen very small gains, but not much. Since 1979, the middle class wages are up only 6% and low-class wages are down 5%. The only people to do well? Very high earners—or the ultra rich—with a 41% increase.

Inflation is coming!

What is inflation?

Before we get into the effects of inflation on wage growth, I want to take a moment to define inflation.

The simple definition of inflation is when prices rise and the purchasing power of a currency drops. It means that you can buy less with your money than you used to be able to.

All economies experience inflation (and deflation) at some point. But where it gets troublesome is when the income levels of a population don’t track with or exceed inflation. In that case people become poorer, even if they think they are making more money.

What causes inflation?

There are different ways inflation can happen in an economy.

  1. Rising demand for goods can cause the supply to go down, thus increasing prices. You can see this in a hot housing market where the number of people wanting to buy a home is larger than the number of homes on the market.

  2. Rising costs for things like labor and materials can result in the increase of prices. For instance, a while back the global prices of hops went up and the cost of a six pack went up a couple dollars. I remember buying beer a few years ago for $6.99 a six pack. Today it can be $9.99 or higher.

  3. The relationship between the rising costs and workers wage expectations also contribute to inflation. This is called the “wage-price spiral". Simply, it means that as prices go up, workers expect to be paid more…which in turn makes prices go up.

  4. A fourth way inflation can happen is when the government manipulates a money supply, like the U.S. has done with quantitative easing. Injecting more money into the system allows banks to issue more debt, which causes prices to increase. Push too much into the system, however, and things can go very bad.

What types of inflation are there?

There are many types of inflation but the main three are creeping, walking, and Galloping or hyperinflation.

  1. Creeping inflation is the normal, mild inflation most economies want and expect. For instance, the Federal Reserve sets their polices hoping to target a 2% inflation rate. This is considered healthy for an economy, and theoretically employee wages can keep up with this.

  2. Walking inflation is an acceleration of inflation in the the 3-4% territory. This starts to become harder for wages to keep up with and people begin to feel poorer.

  3. Hyperinflation is extreme inflation that can go as high as 20%, 100%, 200%, or even more. In the Weimar Republic hyperinflation was so extreme that “A loaf of bread in Berlin that cost around 160 Marks at the end of 1922 cost 200,000,000,000 Marks by late 1923.”

The effects of inflation on wage growth

Unfortunately, most of the workers in the U.S. have seen their meager wage gains erased by inflation. As “The Washington Post” reports, “Cost of living was up 2.9 percent from July 2017 to July 2018, the Labor Department reported Friday, an inflation rate that outstripped a 2.7 percent increase in wages over the same period. The average U.S. “real wage,” a federal measure of pay that takes inflation into account, fell to $10.76 an hour last month, 2 cents down from where it was a year ago.”

The culprits for this increase in costs? Energy, housing, health care, and care insurance. Basic needs. Again, the only people seeing wage growth are high-paid folks. This is because companies are focusing on rewarding high-skilled workers only with raises, in what The Bank of England Governor, Mark Carney, calls the “massacre of the Dilberts.”

This, unfortunately, is nothing new. The average pay for a U.S. worker has not risen relative to inflation for decades. As PEW reports, “After adjusting for inflation, however, today’s average hourly wage has just about the same purchasing power it did in 1978, following a long slide in the 1980s and early 1990s and bumpy, inconsistent growth since then. In fact, in real terms average hourly earnings peaked more than 45 years ago: The $4.03-an-hour rate recorded in January 1973 had the same purchasing power that $23.68 would today.”

The effect of inflation is to make people poorer

Now, to some, inflation is bad news because they don’t know how to use inflation to get richer. So, instead, inflation makes them poorer. For instance, employees are hurt by inflation because they can only sell their time, and time generally does not hedge against inflation well. Raises, if they come at all, generally come on an annual basis after inflation—not with it. And as I’ll share below, now they’re only coming for those who are highly-skilled and hard to replace (for now).

Additionally, people who are deep in credit card debt or who have interest ARM loans are hurt by inflation because the Fed generally raises interest rates to combat inflation. Much bad debt is based on adjustable interest rates that go up during times of inflation, making debt payments more expensive.

Finally, people who play by the old rules of money are hurt by inflation because they believe it is wise and prudent to save money in the bank. But the bank is smart, not dumb. And the bank plays by the new rules of money. They pay interest on money that doesn’t keep up with inflation. Money loses purchasing power as the bank uses your money to make more money.

No matter where you turn, things look grim for the middle class worker. But rather than focus on the negative, I want to share what my rich dad taught me about how to thrive in an economy with inflation.

How to profit from inflation

The rich, however, have learned how to make money during inflation: leverage and hedging.

I play the bank’s game. I borrow money from the bank at a fixed rate, buy a cash flowing asset that covers the debt payment, and using less of my own money increases my return on investment.

In an inflationary economy, if the debt payment is fixed, it becomes less of a cost as the dollar loses purchasing power and my investments and income grow.

The reason my investments and income grow is because I purchase assets that hedge against inflation. For instance, in inflationary economies, rents generally rise. When I purchase investment property, the debt payment stays the same while my rents rise due to inflation. This creates more cash flow. I owe the bank only the agreed payment. The rising costs for rent flow straight into my pocket.

The same thing happens for businesses. As the cost of goods rise for consumers, businesses can adjust their pricing and benefit from inflation.

This works because business owners and investors aren’t selling time. They’re selling product that hedges against inflation in relatively real time. They are in control. Employees aren’t in control of their product—time—nor are they in control of their money (the bank or mutual fund is).

One other thing I do to hedge against inflation is invest in commodities. Recently that has been energy products like oil, a great investment when there is inflation. Not great when there’s deflation.

Therefore, while I believe they are good investments for me, they’re not good investments for everyone—especially people who are still learning about the economy and investing who may not be able to react quickly to changing economic conditions.

At the end of the day, what I’ve been preaching all along—invest for cash flow—is the safest and soundest strategy that will serve you well in an inflationary economy. It’s a sure way to grow richer.

Original publish date: August 14, 2018