2022 is almost here. With the arrival of the New Year, we always like to take some time to reflect on the best ways to set ourselves up for success over the next 12 months. With the possibility of more lock-downs due to COVID-19 and headlines predicting rising inflation and prices, many people are worried about what the future holds. Fortunately, there are steps we can take to protect ourselves from both the pandemic and inflation, one of which is a robust vaccination program. 😂
But how can we vaccinate ourselves against inflation in such an inflationary environment? Recent news articles have reported that inflation has reached an 18-year high, sitting at 4.7%. This is the highest it's been since 2003, and predicting how long it will last is uncertain.
To address this question, let's first understand what inflation means. Inflation is the general increase in prices and the corresponding decrease in the purchasing power of your money. This means that your money is losing value at a rate of 4.7%. If your investments aren't generating at least that amount in returns, your purchasing power is declining.
So What Can We Do?
Step 1 - Pay off bad debt.
We've all heard financial experts like Dave Ramsey emphasize the importance of eliminating certain types of debt. High-interest loans, credit card debt, payday loans, and car loans are examples of debts that should be prioritized for repayment. Why? Because these types of debt are either unsecured or secured against liabilities that generally depreciate over time. Once these debts are under control (not necessarily fully paid off but on an affordable payment schedule), move on to step 2.
Step 2 - Buy assets, with leverage (debt).
What constitutes an asset? In financial accounting, an asset is any resource owned or controlled by a business or economic entity. It's something that can generate positive economic value and tends to appreciate over time. Assets are items in demand with limited supply. For example, consider the impact of supply and demand on the housing market in Canada. Check out this post.
Let's illustrate it this way. Suppose you bought a house for $80,000 in the 1980s or 1990s and financed it at 100% loan-to-value (LTV). At the time, this might have seemed unconventional, but if you've made interest-only payments over the last 20 or 30 years and still owe the original amount borrowed, you could be sitting on a $500,000 to $1,000,000 asset while owing only $80,000. This demonstrates the power of holding assets like real estate in an inflationary environment.
But why use debt to purchase such an asset instead of paying cash upfront?
First, if you can afford to buy a house with cash, that's commendable. Click on the link at the bottom of this post and we can discuss how to make the most of it.
Second, 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.
While leverage is a useful tool, we must also be careful not to over leverage and maintain cash on the sidelines to get us through any rough patches.
Let's face it; time is not on our side when it comes to inflation. Missing an opportunity to make a purchase now, only to find the same item costs an extra $10,000 in six months, not only means you miss out on potential gains (opportunity cost) but also spend $10,000 more than you would have, resulting in a $20,000 loss. Act promptly, but don't rush. Just because inflation is surging doesn't mean you should impulsively make purchases. While real estate may have been a lucrative investment in recent years, there's no guarantee this trend will continue indefinitely. The best strategy for real estate is to enter with a well-thought-out plan, including entry and exit strategies, and conduct thorough due diligence to weather the inevitable market fluctuations that come with investing. We must still adhere to sound fundamentals and invest in properties that generate positive cash flow. If you're unsure about what qualifies as a good property or where to find one, we can assist with that.
Have questions about your portfolio or want an outside opinion? Please select the button provided below, and I will schedule a free half-hour call with you to go over your situation! Talking to the right people can really save you money. I really believe that this is the time to expand your network and learn from those around you. I'll be in touch!
I'd love to hear your thoughts on this! Have a great week while working past those obstacles on your climb to success. Let's Grow Together!
Real Estate Investor and Entrepreneur
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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