Many people claim that real estate is a good ‘hedge’ against inflation. But what does this mean and, more importantly, is it really true?
Well, to answer those questions, you first have to understand what inflation is and how it can affect your finances.
Inflation is when the price of goods and services rises over time. And because things cost more, the dollar in your pocket buys less. While this might seem like a ‘bad’ thing, a little bit of inflation is a ‘good’ thing as it is a sign the economy is healthy and growing.
After all, if the economy is growing, you have more money to spend – and it’s this higher spending that’s pushing prices up. Ideally, wages then go up broadly in line with inflation, so no one is worse off.
However, problems start when inflation starts outpacing income growth – whether that’s from a salary, investments, pension or another form of retirement income – as this means, effectively, you are getting poorer.
This is why the Reserve Bank of Australia tries to keep inflation between 2-3%, on average, over time – as it’s seen as a good balance between encouraging economic growth and preserving the value of your money.
Read more: What is lifestyle inflation?
How to protect yourself from inflation
Countering inflation as an investor is, in theory at least, relatively straightforward: you need to make sure your investments are bringing in a return that’s greater than the rate of inflation.
But this is easier said than done, particularly in an inflationary climate. That’s because the interest rates offered on low-risk investments such as term deposits typically won’t keep up with inflation. As a result, your savings are going backwards.
Conversely, higher-risk investments such as shares might offer a return that beats inflation, but – if things go badly – you stand the chance of losing all your money.
Why real estate can be a good hedge against inflation
In general, real estate is considered a good hedge against inflation for three reasons.
Firstly, history tells us that property prices have risen in value over the long term at a rate that’s exceeded the rate of inflation.
Secondly, while your property’s value will likely rise over time, your debt naturally decreases – as you pay down your home loan. But here’s the clever part: you’re paying back the lender with money that’s worth less than when you originally borrowed it.
Thirdly, rents usually rise alongside prices. So if you buy an investment property and rent it out, any income you receive should hopefully keep pace with, or even exceed, the rate of inflation.
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