Why Holding Assets (And Debt) Is Good In An Inflationary Environment
Updated: Jul 21, 2022
2022 is almost here. With the coming of a New Year, we always like to take some time to reflect on the best ways to set ourselves up for success over the coming 12 months. With more lock downs on the horizon due to COVID-19, and bold headlines of coming inflation and rising prices, it can leave many worried about what the future holds. Luckily, there are some things we can do to protect ourselves from both the pandemic and inflation: a robust vaccination program. 😂
But how do we vaccinate ourselves against inflation? Recent news articles are telling us that inflation has hit 18 year highs and is sitting at 4.7%. The highest it’s been since 2003 and how long it will last is anyone’s guess.
To answer this question, let's look at what inflation means. Inflation is the general increase in prices and a corresponding fall in the purchasing power of your money. It means that your money is losing value at a rate of 4.7%. If you aren’t making at least that amount in your investments, your purchasing power is going down.
So What Can We Do?
Step 1 - Pay off bad debt.
We've all heard the Dave Ramseys of the world pontificate about how evil debt is many times throughout our lives. To an extent, and in certain circumstances, paying off debt is the right thing to do. High interest loans, credit card debt, pay day loans, and car loans are all examples of debt that should be dealt with as fast as possible. Why? Because these types of debt are either not secured against anything, or in the case of a car loan, secured against something that generally decreases in value over time. After these types of debts are under control (not necessarily paid off, but at least on an affordable payment schedule) move to step 2.
Step 2 - Buy assets, with as much debt as the bank will give you.
What's an asset? In financial accounting, an asset is any resource owned or controlled by a business or an economic entity. It is anything that can be used to produce positive economic value and tends to appreciate (get more valuable) over time. An asset is something that is in demand yet has limited supply. For an example of what supply and demand is doing to the housing market in Canada, check out this post.
Put it this way. Say you bought a house for $80,000 in the 1980s or 1990s. If you had financed it at 100% loan to value (LTV) when you bought it, everyone would have thought you were crazy. However, if you had paid interest only payments over the last 20 or 30 years, and still owed the exact amount that you borrowed, you would be sitting on a $500,000 to a $1,000,000 asset that you only owe $80,000 on. This is the power that holding an asset like real estate can provide.
But why use debt to purchase this asset? Why not use cash and pay it down as fast as possible?
First, if you can buy a house with cash, good for you. Contact me here to discuss how we can put it to good use. 😁
We are in a low interest rate environment and have been for a long time. If inflation is ripping at 4.7% and the bank is only charging you 2.7% interest, guess who is making 2% on money that isn’t even theirs? Just like in our previous example, the value of the asset rises at a pace close to inflation while the loan against it decreases in value at the same rate. Worried about interest rate hikes? You can lock in a 5 year rate now to avoid facing any short term hikes. Just be aware that having a variable rate is often more cost effective over the long run.
Let’s face it. Time is not on our side here when it comes to inflation. If you miss an opportunity to purchase something now, and it costs an extra $10,000 in 6 months when you get around to making the purchase then, you have not only lost the $10k that you could have made (opportunity cost) you are also spending $10k more than you would have spent, resulting in a $20,000 loss. Act now, folks.
But don’t act too fast. Just because inflation is ripping, doesn’t mean that you should go running out and buying everything in sight. Yes, it has been pretty easy to make money in real estate the last few years. That doesn’t mean this environment is going to continue indefinitely. The best insurance policy for real estate is going into it with a plan of entry and exit and doing your due diligence to ensure that you can weather the inevitable storms that comes with investing. We still have to abide by our fundamentals and purchase a good property that will cash flow at the end of the month. Not sure what qualifies as a good property or where to find one? We can help with that.
Jonathan Beam is a real estate investor in the Niagara region who is passionate about helping you achieve financial freedom through real estate. He works with new and experienced investors to formulate a plan that fits your specific situation and provides market guidance and consultation on the best places and strategies to pursue within the Niagara Region. Book a free, half hour no obligation consultation to see how he can help you to achieve your goals. His travels are available at www.realestateandrepeat.com
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