The Impact of Inflation on Your Investments: How to Protect Your Wealth

Introduction

Inflation is an economic phenomenon that directly affects the purchasing power of currency and, consequently, the profitability of investments. In a scenario of high inflation, the money you have today will be worth less tomorrow, eroding the real value of your assets. Understanding how inflation works and, more importantly, how it impacts your investments is crucial for any investor seeking to preserve and multiply their capital in the long term. This article explores the mechanisms of inflation, its effects on different asset classes, and essential strategies to protect your portfolio in times of economic uncertainty.

What is Inflation and How is it Measured?

Inflation is the generalized and continuous increase in the prices of goods and services in an economy. This means that, with the same amount of money, it is possible to buy fewer products and services over time. Inflation is measured by price indices, with the Broad National Consumer Price Index (IPCA) being the main official indicator in Brazil [1]. The IPCA reflects the variation in the cost of living for families with incomes ranging from 1 to 40 minimum wages, covering various categories of expenses, such as food, transportation, housing, and health.

Causes of Inflation:

•Demand-Pull Inflation: Occurs when the demand for goods and services exceeds the economy's production capacity. More money circulating for the same amount of products leads to price increases.

•Cost-Push Inflation: Results from an increase in production costs, such as raw materials, energy, and wages. Companies pass these higher costs on to consumers through elevated prices.

•Inflationary Inertia: This is the persistence of inflation due to price and wage indexation mechanisms, which seek to compensate for past losses, creating a vicious cycle.

•Inflationary Expectations: The expectations of economic agents about future inflation can influence present price and wage decisions, contributing to inflation itself.

How Does Inflation Affect Different Investments?

Inflation's impact varies significantly across different asset classes. Some investments are more vulnerable to inflationary erosion, while others can offer protection or even benefit from this scenario.

Fixed Income:

Fixed-income investments, such as CDBs, LCIs, LCAs, and Treasury Direct bonds, are particularly sensitive to inflation. If the nominal return of these investments is lower than the inflation rate, the investor will experience a loss of purchasing power. For example, a CDB yielding 10% per year with an inflation of 12% per year results in a real loss of 2% [2].

•Pre-fixed Bonds: These are the most vulnerable to unexpected inflation. If inflation rises above the contracted rate, the real return will be lower or even negative.

•Post-fixed Bonds (linked to Selic/CDI): Offer some protection, as their returns follow the basic interest rate, which is generally adjusted to combat inflation. However, the real return can still be low if the Selic rate does not significantly exceed inflation.

•Inflation-Indexed Bonds (IPCA+): These are the most suitable for inflation protection. The return is composed of a pre-fixed rate plus the variation of the IPCA, ensuring a real gain above inflation. Examples include Tesouro IPCA+ and some CDBs and CRIs/CRAs indexed to the IPCA.

Variable Income:

The impact of inflation on variable income, such as stocks and real estate funds (FIIs), is more complex and depends on various factors, including the company's sector and its ability to pass on costs.

•Stocks: Companies with strong pricing power (ability to increase prices without losing customers) and operating in essential sectors (energy, sanitation, telecommunications) tend to perform better in inflationary scenarios, as they can pass on increased costs to consumers. On the other hand, companies with tight margins or those dependent on imported inputs may suffer from inflation [3].

•Real Estate Funds (FIIs): Many FIIs, especially those that invest in physical properties, can be negatively impacted by inflation if rents are not adequately adjusted or if there is vacancy. However, paper FIIs (which invest in real estate debt securities, such as CRIs), many of which are indexed to the IPCA, can offer good protection against inflation.

Strategies to Protect Your Wealth from Inflation

Protecting your wealth from inflation requires a strategic and diversified approach. There is no single solution, but combining different assets and tactics can mitigate risks and even generate real gains.

1. Invest in Inflation-Indexed Assets:

As mentioned, bonds like Tesouro IPCA+ are excellent tools to ensure your investment preserves its purchasing power. They pay a real interest rate (above inflation), protecting your capital from inflationary erosion. Other options include CDBs, LCIs, and LCAs indexed to the IPCA, and some investment funds that follow inflation indices.

2. Diversify Your Portfolio:

Diversification is key to any successful investment strategy, and in inflationary scenarios, it becomes even more crucial. Distributing your investments across different asset classes (fixed income, variable income, multi-market, foreign currencies, commodities) and economic sectors helps reduce exposure to specific risks and capture opportunities at different moments of the economic cycle. For example, while pre-fixed fixed income may suffer, stocks of companies with pricing power may appreciate.

3. Consider Real Assets and Commodities:

Real assets, such as real estate, and commodities, such as gold and silver, historically serve as a store of value in times of inflation. Gold, in particular, is seen as a safe haven, as its price tends to rise during economic uncertainty and inflation. Investing in real estate funds (FIIs) or physical properties can also be a form of protection, provided that rental contracts include inflation adjustments.

4. Foreign Currencies:

Holding a portion of your wealth in strong currencies, such as the dollar or euro, can be an effective strategy to protect against the depreciation of the local currency in high inflation scenarios. This can be done through currency funds, currency ETFs, or even accounts in international banks.

5. Stocks of Companies with Pricing Power:

Prioritize companies that can pass on their increased costs to the prices of their products and services without losing customers. These are generally companies with strong brands, essential products, or those operating in sectors with little competition. Sectors such as electricity, basic sanitation, and telecommunications are examples of sectors that often have contracts adjusted by inflation indices.

6. Financial Education and Planning:

Finally, the best defense against inflation is knowledge. Understanding concepts, monitoring economic indicators, and having a solid financial plan are fundamental. Periodically review your portfolio, adjusting it according to market conditions and your long-term goals. Financial education allows you to make informed and proactive decisions, transforming inflation from an enemy into a factor to be managed.

Conclusion

Inflation is an economic reality that cannot be ignored. Its effects can erode purchasing power and the real value of investments, but with the right strategies, it is possible to protect and even grow your wealth in an inflationary environment. The key lies in diversification, choosing assets that offer inflation protection, and continuously seeking knowledge. By adopting a proactive stance, investors will be better prepared to navigate market uncertainties and achieve their financial goals, regardless of the economic scenario.

References

[1] Banco Central do Brasil. What is inflation. Available at: https://www.bcb.gov.br/controleinflacao/oqueinflacao

[2] Exame. How inflation affects your investments and how to protect yourself from it. Available at: https://exame.com/invest/guia/como-a-inflacao-afeta-seus-investimentos-e-como-se-proteger-dela/

[3] InfoMoney. High inflation? 10 stocks of companies with pricing power to face the scenario. Available at: