Warnings against rising inflation often make it to the headlines of financial news papers, especially now as the world is coming back to its normal life after the global pandemic and people are ready to spend again. Inflation is a potential challenge to look out for in your trading and investing process, as it erodes the real value of your holdings, takes away from your total returns and often leads to higher interest rates. Investors and traders therefore often search for ways to protect their portfolios against this economic phenomena. So, how does inflation affect trading and investing on eToro and what are some of the ways in which you can protect your portfolio from unexpected inflation? Here are some things you might want to consider.
(NOTE: Before we continue, we have to give a disclaimer that the trading products offered by the companies listed on this website carry a high level of risk and can result in the loss of all your funds. CFDs are complicated instruments that are never guaranteed to provide you supplemental earnings. In fact, Around 68% of all retail investors experienced a loss while trading CFDs. Make sure to keep this in mind before attempting to use the eToro platform yourself. All the information found on this website is not official trading advice and all practices shown are referenced for the use of the Demo account only.)
What is inflation?
Inflation is a measure of how fast prices change in the economy overall. Moderate inflation is a natural process for a growing economy: as the economy keeps on expanding, more products are being manufactured and demanded, businesses and regular consumers spend more and more on various goods and services, and this increase in demand leads to a certain price increase. What does it mean for you as an investor? Well, in simple terms, $1 dollar 10 years ago cannot buy you the same amount of stuff as it can now exactly because prices of goods increase over time due to inflation. It also means that if you put $1,000 into your bank account right now in 10 years it will not represent the same value as it does now and you will not be able the same amount of goods with it. So, for you as an investor on eToro, inflation can present a threat to the investment portfolio by taking away from its real value. Following a similar logic, because of higher inflation and interest rates the present real value of future cash flows and earnings of firms is now smaller, reducing the value of equity you might be holding. What can you do to avoid this unfortunate situation? Earning a return on assets that can potentially compensate for the loss due to inflation or simply outperform the market during such economic conditions can be one of the ways to protect yourself. Let’s look at some of these possible assets in greater detail.
This a broad category of assets offered on eToro, including metals and basic agricultural goods like sugar and wheat. Commodities have a very special relation to rising price levels, as they are often thought to be an indication of upcoming inflation: they are both a source and a driver of inflation. This is because an increasing price of a commodity indicates that there is a possible price increase of products that require it for production; for example, if there is an increase in prices of various metals, that is likely to lead to increased prices of all the goods made out of them, pipes, metal components, car parts, transportation, various equipment, cutlery, electronics even and many others, bringing up the average price level of the economy. There is therefore an opportunity to take advantage of this relationship in an upward price trend for commodities on eToro. The platform offers these assets for purchase directly, as well as allows to gain a broader exposure to them through ETFs; remember however, that commodities are very volatile assets and need to be traded with caution, knowledge of trading basics and risk management tools.
This is perhaps the most common commodity that is used as a hedging tool against inflation. Since gold, as a physical asset, has actual intrinsic value and limited supply which is different from, for example, money, which can be printed by the government and who’s value can be eroded, it is often considered to be an alternative currency and used for inflation hedging. Therefore, at times it can be considered to be a relatively better performing asset during the times when inflation is rising.
How does one add gold to their eToro portfolio? There are several possibilities:
- Through CFDs, and although they do not provide you with the actual ownership of the asset, but offer a direct exposure to it and allows you to open both a long and short position. Please remember that CFDs are complex financial instruments and come with a high risk of losing money rapidly due to leverage. 68% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work, and whether you can afford to take the high risk of losing your money.
- Investing through Exchange traded funds (ETFs); eToro offers several ETFs that focus on a broad exposure to various commodities and also specific ones such as gold, like shown on the image below; please bear in mind that the below asset was chosen for exemplary purpose and does not actually constitute an investment advice.
- Apart from investing into gold directly eToro also allows you to invest into stocks of companies that actually mine it as their value increases in line with the rising prices of gold and other metals.
- eToro also offers a Gold and Energy oriented CopyPortfolio that offers exposure to a wide variety of assets from the energy and gold sectors in a ready-made portfolio that is frequently monitored and re-balanced, like on the image below. Remember that past performance is not an indication of future results and these products do not guarantee a positive return.
The downside of holding gold comes from the fact that it delivers no yield besides having an intrinsic value, especially at the times of rising interest rates. Gold in itself is therefore not really a perfect tool for hedging inflation.
Oil is another commodity central to economic activity that is often used for hedging inflation, which may come as a surprise as it is considered to be one of the key drivers of inflation at the same time. Strong economic environment leads to higher demand for oil and all of the products and services that require it for production, alongside rising prices. Oil therefore has a potential of outperforming other market assets during inflation.
How can you invest into oil on the eToro platform? In many ways these methods are very similar to investing into gold:
- Purchasing the asset directly through CFDs, allowing you to open both long and short positions. CFDs are complex financial instruments and come with a high risk of losing money rapidly due to leverage. 68% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work, and whether you can afford to take the high risk of losing your money.
- Investing into stocks of companies that produce oil as they tend to fluctuate alongside actual oil prices (so if oil prices rise, prices of equity of oil-producing companies tend to rise likewise because they are now generating more profit). However, this approach now also exposes you to risks associated with investing into that specific company i.e. company-specific risk.
- eToro offers energy and oil oriented CopyPortfolios, ready-made financial product that combines stocks of oil-producing companies, related ETFs and futures. These products offer additional diversification as they reduce asset-specific risk by spreading investment over a larger number of instruments.
Stocks of Banks
How are banks affected by interest rates? In case inflation leads to increase in interest rates, as it often does, banks can not benefit from higher profits earned from these interest rates and spreads (differences between rates for borrowing and lending), and the value of their equity would increase likewise. In simple words, inflation and higher interest rates are good news for the banks. eToro directly offers stocks of several banks as well as a CopyPortfolio that combines several stocks of banks into a single diversified product; remember however that past performance of these products does not guarantee future results.
There are, of course, many other techniques for hedging against inflation one might consider.
- 60/40 stock and bond portfolio. This is quite a conservative, relatively ‘safe’ and easy investment approach which involves mixing together stocks and bonds. Of course by the principle of risk-return relationship, this portfolio of lower volatility tends to deliver lower returns in the long-run and you might miss on potentially higher returns of riskier stocks.
- Real Estate investment. There are companies that focus on investing and managing income-generating real estate assets; prices of properties tend to increase during the times of higher inflation which is beneficial to those investing into it. Somewhat similar to gold, real estate has intrinsic value as well as appreciation potential. eToro offers ETFs as a way of investing into real estate.
- Investing into the market itself. This involves investing into indices that track the market, such as the S&P500, as stock on average tend to outperform other asset classes in the long-term.
Please bear in mind that these are some of the common inflation hedging techniques used by investors but they do not guarantee a risk-free return.
Hopefully now you have a better idea of how inflation works, what are some of the ways in which it affects your eToro portfolio and what are the ways in which you can protect yourself. Remember that trading and investing always involves capital loss risks and enjoy trading on eToro. Best of luck to you!
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Please note that CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 68% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work, and whether you can afford to take the high risk of losing your money.
Past performance is not an indication of future results. Trading history presented is less than 5 complete years and may not suffice as basis for investment decision.
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