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Inflation is never far from an investor’s mind. It’s often seen as a negative force in the economy, and it’s true that extreme inflationary conditions can threaten investment portfolios, along with the larger economic climate. Concern is especially keen in the post-pandemic conditions of 2021.
But inflation is also a fundamental part of the economy, and there’s a lot that thoughtful investors can do to protect their assets—what’s known as “hedging” against inflation. Diversifying into alternative assets like farmland can help fortify a portfolio in case of inflation, not to mention shield from other risks.
This article gives a basic introduction to inflation, how it works, and how it’s measured and managed within the U.S. economy. Then it dives into methods of hedging against inflation, the principles of portfolio diversification, and how AcreTrader offers options that can help strengthen your portfolio with the often overlooked asset class of farmland.
Part I: Understanding Inflation
What is inflation?
Put very simply, inflation is a general rise in prices over time.
This doesn’t mean the price of any one particular good or service. Rather, it indicates an average of a broad set—a “basket,” as the Bureau of Labor Statistics terms it—of prices of common goods and services within an economy. Inflation measures like Consumer Price Index, or CPI, serve as a good indicator of how much people are paying for everyday necessities.
Our national and even global economy is vastly interconnected and interdependent, so over time, prices tend to rise or fall all together. That’s inflation.
In 1900, the average cost of an acre of agricultural land was $20. One hundred years later, that number was $1,050, an increase of more than 52 times.
If this shift happened overnight, or if land was the only thing that rose so sharply in price, it would be a pretty shocking anomaly. But over such a long timespan, most assets and goods have generally increased in price at the same time, just not at the same rate.
The basic principle of inflation is that you don’t get as much for your dollar as you did before. A slow pace of inflation is considered normal because that’s the basic trajectory of economic development. Keep in mind, the average household income in 1900 was $450 a year.
By setting interest rates and other controls, the Federal Reserve aims for a 2% inflation rate over time. This is where we tend to see optimum price stability and employment. Generally speaking, a slow, steady increase in inflation is thought to signal a healthy economy.
It’s worth noting that the U.S. has not reached 2% inflation per year for more than a decade; currently, we are in a historically low inflationary environment. While some worry that easy monetary policy will lead to high inflation, there are countless other factors that can drive price levels. Increasing globalization and technological advancement are two of the most commonly cited.
Inflation becomes problematic when it gets out of balance with other economic indicators, such as real wages. When growth doesn't keep up with the price of goods, money’s purchasing power deteriorates. There may still be plenty of money within the economy, but it won’t buy as much as before. The money supply exceeds people’s ability to spend it, prices keep rising to make up the difference, and inflation can start getting out of control.
What causes inflation?
This is why some people worry about inflation in connection with certain types of government spending, such as the stimulus bills of 2020 and 2021. The concern is that more money being introduced into circulation dilutes its value, resulting in a sharp rise in prices.
Economists have several theories about how this actually happens, but they all describe the same basic cycle: prices outpacing people’s ability to pay.
- Demand-pull inflation is the idea that an increase in available money and credit create more demand for goods and services. That demand outpaces the economy’s production, and prices rise in response.
- Cost-push inflation is a scenario wherein businesses’ costs of production rise, and down-market prices rise to keep up. Demand stays level, however, and now goods are less affordable for consumers.
- Built-in inflation happens when people expect inflation to continue pushing costs up, so workers demand higher wages in order to keep pace. This leads to what’s known as a wage-price spiral—a spiral that travels, you guessed it, upward.
How is inflation measured?
The most common inflation measure you see is CPI, or Consumer Price Index. It indexes the price of everyday consumer goods like bread and milk, as well as everyday costs like municipal water bills and sales tax, measuring the change in basic cost of living.
Actual CPI is a straightforward number (263.014 in February 2021), but you’ll typically see it as a percentage, which represents the change in inflation over 12 months. In February, that percentage was 1.7, meaning the price index had risen 1.7% since February 2020.
The other most frequently referenced metric in the U.S. is the Producer Price Index, or PPI, which looks at inflation through a business lens, averaging the change in selling prices for goods and services within an economy. PPI figures work the same way as CPI, and in February 2021, PPI was up 2.8% from February 2020.
Inflation on its own isn’t necessarily good or bad. It can help keep consumer demand for products and services high, strengthening the job market and motivating people to put their money to use. For borrowers, inflation tends to be positive, as the value of their debt decreases over time.
On the other hand, inflation can hurt savings, as sitting money will be gradually losing value as the economy grows. Trouble arises when inflation builds its own momentum and runs wild, sometimes known as hyperinflation.
Where does inflation stand in 2021?
Concern about inflation has grown in the past year and a half. With the economy slowed by the Covid-19 pandemic and its aftereffects, the risk on many minds is that money being introduced by stimulus spending could trigger an out-of-bounds inflationary cycle. Since February 2020, the U.S. money supply has grown by nearly 25%, compared to 5.8% per year between 2010 and 2019.
Some investors recall the severe inflation of the 1970s, which was caused by a combination of government policy and market psychology. In a less than two-year window, CPI jumped by almost nine percentage points, up to 12.3. We’re not seeing those sharp inclines today, but it’s reasonable to keep an eye on inflation amid the economic changes we’re feeling in the U.S. and around the world.
Inflation is a topic with the potential to be politicized or controversial. But the basic concern for many Americans is simple: they’re looking to safeguard the assets they’ve worked hard to gain.
Part II. Hedging Against Inflation
What does inflation risk mean to investors?
Investors are smart to think about inflation because their financial assets are prone to fluctuation brought about by changes in the value of money. As the gap between the value of the dollar and prices of common goods widens, consumers may find themselves with less discretionary income to invest or save. This can have a major impact on liquid investments like stocks, savings accounts, etc. because consumers actually need that money to afford a higher cost of living.
What can investors do about inflation risk?
Combating inflation and other well-known portfolio risks such as price volatility is often referred to as “hedging.” Once upon a time, hedges worked as fences, keeping livestock in and—hopefully—predators out. Applied to investments, hedging is an attempt to protect the value of your investments by choosing to invest your money in assets with different characteristics.
This shouldn't be a new concept to any of us; just remember your parents telling you, “Don’t put all of your eggs in one basket,” or “Don’t spend it all in one place!”
What is portfolio diversification?
Diversifying your portfolio is making sure you own different kinds of assets so that your risk is spread out. Risk that exists in one place won’t necessarily exist in another. This is why most investors typically buy and hold several different stocks, and why many people keep money in both stocks and bonds.
The goal of portfolio diversification is to ultimately minimize your risk exposure to a level you are willing to accept in order to stabilize your returns.
For example, you likely wouldn’t want to completely eliminate stocks from your portfolio because they have the potential to generate a bulk of your returns over time. However, their value can also go down 40% or 50% in a single year. By investing in bonds, you are essentially purchasing an insurance policy by purchasing an asset with a history of far more stable, albeit lower returns.
Maintaining a diverse portfolio is an essential principle of investing, and inflation isn’t the only reason to diversify. Ideally, your total investment portfolio stays healthy even as particular segments experience natural ups and downs.
What are real assets?
An important component of a diversified portfolio is assets that aren’t financial. When the value of money starts to shift, you hold value somewhere else.
In contrast to financial assets like stocks and bonds, real assets are physical assets with intrinsic worth. Think precious metals, commodities, real estate, land, equipment, and natural resources. They’re typically pretty uncorrelated to the stock market.
Some of the most common real assets investors choose are:
- Real Estate: Properties used for business or rental purposes that have long been a way for larger investors to protect their money from inflation and earn rental income.
- Gold: Gold has traditionally been viewed as the ultimate real asset if your goal is to store value as a hedge against inflation.
- Bitcoin: Many investors see bitcoin and other emerging cryptocurrencies as viable alternatives to traditional assets.
Part III: Farmland as a Hedge Against Inflation
Experts have long touted gold as the go-to investment in times of rising inflation, but many people don’t know that farmland has actually performed better than gold when it comes to inflation.
Farmland values have historically tracked inflation very closely, with a 70% correlation with the Consumer Price Index (CPI) and a 79.84% correlation with the Producer Price Index (PPI). This is because when food prices increase, farmers get higher commodity prices, and land is more valuable.
Farmland has consistently generated relatively high returns, even during periods of high inflation. From 1960 to 2012, at an average inflation rate of 4%, farmland has averaged returns of 11.1%. In comparison, gold values rose by about 8%.
Farmland has also outperformed commercial real estate over time. Commercial properties have been shown to offer slightly higher annual distributions. However, if you take into account both rental income and growth in value (also known as appreciation), farmland returns have averaged almost 12% since 1990 while commercial properties have realized an approximately 6% total return. This reflects CRE’s higher volatility.
Plus, quality farmland has a near-zero vacancy rate, on top of relatively lower maintenance and management expenses.
What are some other benefits of investing in farmland?
In addition to its relative stability when it comes to inflation, farmland also has many other features that make it particularly attractive for investors looking to diversify their portfolios.
- Low volatility: Farmland has generated positive annual returns every year for the last 30 years. Compared with other major assets, the volatility of farmland returns has been extremely low.
- Favorable supply and demand: The global population is growing while available farmland is shrinking, suggesting that farmland’s value should only increase in the future.
- Stable, recurring income: Assuming the land’s in operation, the landowner makes money every year from production. Landowners may work the land themselves, seek out and hire an operator to do so for them, partner with an operator in a crop sharing agreement, or act as a landlord in a cash rent arrangement.
How do you start investing in farmland?
Historically, there have been significant barriers for investors to own farmland, mostly associated with the specialized expertise necessary to work in the agriculture industry.
There is always outright ownership, which is in fact the most common method of investing in farmland. The problem is, you have to know how to farm. At the very least, you need to know enough about farming to ensure that the operator you hire will do a good job. And that doesn’t even take into account the time and knowledge it takes to source and purchase a quality piece of farmland.
For investors looking for a more passive investment, there are a couple more options:
- Institutional Funds: Agricultural Land Funds offer institutional alternative asset investors the ability to invest in land at scale. Farmland has attracted a large amount of investment in private equity in recent years.
- REITs: Real Estate Investment Trusts (REITs) are a well-established asset class. Also known as agriculture stocks, REITs are publicly traded companies that typically own and operate real estate using debt to pay out dividends.
- AcreTrader: This online crowdfunding platform helps eliminate some of the friction involved with farmland ownership by allowing investors to skip these pain points with a few clicks and keystrokes.
Land funds and REITS are strong options for many investors, but they are still technically financial assets rather than real, thus they tend to correlate more closely with the stock market than farmland itself.
Land funds often require large amounts of capital up front to invest—think $1M minimums with 10-year lockups. REITS are prone to some of the same volatility that other traditional stocks are. Consider the sharp drop in Farmland Partners, Inc.’s stock following a 2018 report by a short seller that the fund risked insolvency. The company’s holdings remained basically steady, but the stock saw a negative correction of over 40%.
Finally, neither of these options offer direct land ownership—real acres you can point to as owned assets.
How can AcreTrader help you invest in farmland?
Here’s where AcreTrader comes in.
AcreTrader uses some aspects of crowdfunding to provide investors direct access to farmland. Investors are able to own actual U.S. farmland and realize its benefits as an asset class without being an agriculture expert too.
Combining peerless agriculture expertise and tested financial experience, our team responsibly sources and manages investment-grade land deals on behalf of our investors.
Through a rigorous vetting process that accounts for everything from soil quality to local land markets, we eliminate more than 95% of the farms we review. Investors can be certain that any farm offered on our platform is of only the highest quality.
Investors earn money on their investment in two ways: 1) annual distributions from cash rent from the farmer leasing the land as well as 2) land appreciation over time that investors receive upon the ultimate sale of the property. The AcreTrader team handles all aspects of farm management, from sourcing and pre-purchase diligence to leasing, property management, and eventually, disposition.
It’s a simple model that makes it easy for you to own farmland and reap the benefits of this historically well-performing asset class.
It may also be a solid option for investors looking to hedge against inflation. Inflation can be unpredictable, but there are specific actions you can take to protect your assets. Diversification into real assets like farmland can help you retain value through economic swings.
If farmland seems right for your portfolio, we’re here to help. Learn more about how it works.
Note: The information above is not intended as investment advice. Past performance is no guarantee of future results. For additional risk disclosures regarding farmland investing and the risks of investing on AcreTrader, please see individual farm offering pages as well as our terms and conditions.