Even as your investments increase in value, inflation can eat away at what they’re worth.
There are things investors can do to hedge the immediate effects of inflation, or earn a return that outpaces inflation over time. But it can be hard to predict.
“After-inflation returns are the only ones that matter for investors in the real world,” says Robinson Crawford, an investment adviser with Montebello Avenue.
Even if inflation is currently rising more slowly than analysts predicted, it’s better to be prepared.
Financial advisers say one of the most consistent hedges against inflation is a properly diversified stock portfolio.
Equities have historically outpaced inflation, says Sean C. Gillespie, a financial planner with Redeployment Wealth Strategies says that while there is inherent volatility in a stock portfolio, “equities are a long-term asset for your plan just like inflation is a long-term threat.”
To figure out where to put your money in the stock market, investors could look to a total return strategy that relies on equities to provide positive inflation-adjusted returns over the long term.
“Of course, investors have to accept more risk when investing in stocks and endure periods when the returns have not outpaced inflation,” says Dejan Ilijevski, an investment adviser at Sabela Capital Markets. “Although some investors may assume that higher inflation leads to lower stock performance, US market history shows that nominal annual stock returns are unrelated to inflation.”
Gold and commodities
Gold and commodities have been standard havens from inflation for investors.
“Traditionally commodities and gold have been good inflation hedges,” says Stephanie Bucko, a chartered financial analyst and co-founder of Mana Financial Life Design. But she says it is important to take into account the US dollar’s strength as part of this equation.
“We like oil exposure, as this impacts our clients on a day-to-day basis related to gas prices, but it also provides a good inflation hedge,” says Bucko, adding that we saw this in the 1970s as inflation doubled and nominal oil prices skyrocketed.
But commodity markets, for the unfamiliar, can be complex and risky.
“Commodities are volatile, more so than stocks, which means that adding commodities to a portfolio may increase real return volatility, offsetting the benefits of hedging,” says Ilijevski.
Real estate is the ultimate hard asset in times of inflation since it will see price appreciation. Financial advisers suggest investors find a place for real estate in a portfolio.
Investors can gain exposure to real estate by directly owning commercial or residential property, or by investing in real estate investment trusts (REITs).
Real estate is a sound investment, says Crawford. “But I would caution that if you’re not increasing rent in your real estate, you aren’t fighting inflation.”
Short term bonds and TIPS
Short-term bonds and Treasury Inflation-Protected Securities (TIPS) are investments that are a hedge against inflation.
“Hedging seeks out asset classes that tend to positively correlate with inflation,” says Ilijevski.
For example, he says, short-term maturities allow bond-holders to more frequently roll over the principal at higher interest rates. This helps inflation-sensitive investors keep up with short-term inflation.
Similarly, TIPS, issued by the government, are also a fixed-income security hedge against inflation. Their principle is adjusted to reflect changes in the Consumer Price Index. When CPI rises, the principle increases, resulting in higher interest payments.
“TIPS absolutely merit a place in a US investor’s portfolio, especially those with significant bond holdings,” says Crawford. “The main issue is that they increase in value in conjunction with the CPI, which many would argue is not an accurate inflation measure.”