The Best Inflation Hedge

The question “du jour” is: what do you think is the best inflation hedge? The answer may seem unlikely to some, but it can be a worthwhile option.

Before we answer the question regarding the best inflation hedge, I want to highlight that I do not think inflation is going to be a long-term problem. It is a short-term issue that will likely flourish until this pandemic is under better control. I am not an infectious disease expert so I do not know when it will subside, but I am hopeful that Omicron is the last hoorah of COVID-19. If so, then it will surely be going out with a burst of thunder.

I may be wrong about inflation being a short-term issue and that is why a well-diversified portfolio is always important. A well-diversified portfolio is one that has assets assuming there will be inflation, but other investments assuming inflation will not be an issue. Unless you are a speculator you should not invest assuming you know what the future holds.

Circling back to the question we started with, there is one inflation hedge you can use to diversify your portfolio that is a good bet against inflation: a fixed rate mortgage on a first or second home for the longest term possible at the lowest rate possible (and preferably tax deductible). How is a mortgage a tool against inflation?

If I borrow money today at 2.75% for 30 years fixed tax deductible in the 35% tax bracket, then that loan is only costing me about 1.75%. If inflation averages 4%, then I am paying the loan back with deflated dollars that are less valuable then when I borrowed them even after my interest cost.

My father borrowed $75,000 in 1976 to buy a home in Harleysville, Pennsylvania. His interest rate was 6% and as inflation skyrocketed his bank offered him a 10% discount to pay off or pay down his loan. My father chose not to since he was getting 10-15% on other safe cash investments. He was making 5-9% per year on that cash over the cost of his mortgage.

Wisely used leverage is a powerful tool in the fight against inflation. I used leverage to buy our new home in Florida since they offered me 2.5% for 30 years at a fixed rate. Because the leverage was used to buy the home, it was also tax deductible. I could have paid cash and I prefer to be debt free, but this low of an interest rate and being fully tax deductible made it hard to pass up.

There are many good reasons to use wise conservative debt and there are good reasons to be debt free. The tax laws have become complex as to when a mortgage is tax deductible. Make sure you discuss any borrowing decision with your Consulate Advisor to get a well-thought-out, balanced evaluation of both sides.

“Neither a borrower nor a lender be” says Hamlet, but he was referring to borrowing from a friend, which is a whole different article. Leverage, when used wisely, can be a powerful tool against inflation.

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