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Investing During Deflation | How To Invest During Deflation


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Investing During Deflation | An Explanation of What Deflation Is

Deflation

Most investors have no idea how to invest during deflation, because the reality is that deflation is quite a rare occurrence and few investors have any experience with investing during deflation or knowledge regarding the right way to approach investing during deflation.   But, deflation can and does happen, and when deflation happens, it can have a major impact on a wide range of investments. We may actually be on the verge of a deflationary period right now, so it is important to understand measures that should be taken to invest safely during deflation to protect an investment portfolio against deflation. If the right investment movers are made to hedge against deflation, now only will an investment portfolio be protected against deflation, but funds will be available for making investments at the end of the deflationary period to capitalize on the post-deflation rebound.

Before trying to comprehend how to invest during deflation, it is important to understand the definition of deflation, so you understand its implications. Deflation is a sustained and prolonged period of falling prices throughout the economy.   This should not be confused with disinflation, which when inflation is falling to low levels, but still persist just above zero. Deflation is broad and prolonged decreases in prices across the economy.

While deflation might sound great when taken at face value, as prices for common goods, such as food and gasoline fall and become more affordable, a widespread and long-lasting bout of deflation can be very damaging to the broader economy. This is because consumers tend to pull back dramatically during times of deflation, since they assume they can buy goods cheaper if they wait for products to fall further in price. The United States economy is approximately 70% consumer driven, so any significant pullback in consumer spending will have a major impact on economic growth, including the possibility of triggering a recession. Additionally, deflation will eventually cause a reduction in economy activity, as producers reduce their output due to failing consumer demand, a condition known as a “deflationary spiral.” Consumer confidence and spending will be impeded, as wage reductions and layoffs ripple through the economy. Consumers that at first welcome the lower prices that deflation brings, will find the sting of deflation when they lose their job or see their income reduced by their employer.

An Example of Deflation | The Housing Market

The sluggish housing market in the United States since 2006 has been caused by many factors, one of which has been deflation in the housing prices, as potential home buyers held off on purchasing a home, waiting for housing prices to fall. The typical underlying inflation in housing prices was 3% to 4% per year in the United States until the housing bubble burst in 2006 and housing prices shifted into a deflationary mode. Once the inflation pressure to buy a house before prices rise disappeared and changed into deflation, buyers held back, waiting for prices to drop further. Deflation in housing prices also changed the equation that made buying a house preferable to renting, since home buyers were leery of buying a home that would be worth less in the future, rather than more. The investment aspect of home buying was crushed by deflation.

Investing During Deflation | What Not To Invest In

Deflation Investing
First off, let’s talk about what not to invest in during a time of deflation.   A deflationary period is a time to preserve capital and make specific investment choices that will not hurt you as the deflationary episode plays out.

Try to avoid making a large investment in a property, such as a home or investment property, unless you plan on holding it for a long period of time; long after the deflationary spiral has played itself out and real estate prices have resumed their uptrend. If you want to invest in a property, wait until there are signs of price stabilization.   It may be impossible to pick the exact bottom, but it will be worth it to at least wait until the worst of the deflationary period appears to have passed.

Also avoid investing in companies involved in commodity production and consumer goods, as both are likely to see their revenue and earnings severely impacted by deflation, which should cause their stock prices drop sharply.   Companies that carry a high debt burden should also be avoided, as they may have trouble making their debt payments as the economy contracts and their revenues dwindle.

Some Ideas Regarding Investing During Deflation

One of the best ways of weathering a deflationary episode is by simply parking your money in cash equivalent investments that pay interest, such as savings accounts, money market accounts, or short-term Certificates of Deposit (CDs). While stocks and real estate will likely lose value, as deflation affects the economy, cash will increase in value. This is because deflation increases the buying power of cash.   The cash can then be put to work in stocks and real estate investments at lower prices when the deflationary period appears to be ending.
Treasury Bonds
United States Treasury Bonds are another investment that can be considered as a hedge against deflation. While a deep deflationary spiral would likely cause corporate bond prices to fall and potentially lead to corporate bankruptcies and bond defaults, United States Treasury Bonds would continue to pay safe interest payments as deflation ravages the economy.

Get Ready To Invest After Deflation Has Passed

The thing to do while your money is safely invested during a time of deflation is to identify investments to be made as deflation appears to be easing and the economy appears to be at the depth of its contraction. Investing as deflation wanes can actually provide lucrative investment opportunities, since deflationary periods do not last forever.  Money invested wisely or set aside to wait out the worst part of a deflationary episode can be put to work in investments that typically do well during inflationary times, ahead of the return to a normal inflationary investment environment.

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