How can I protect my investments from inflation?
Even as your investments grow in value, inflation can destroy their value.
There are things investors can do to offset the immediate effects of inflation or earn a return that beats inflation over time. But it can be hard to predict.
“Returns after inflation are the only ones that matter to investors in the real world,” says Robinson Crawford, an investment adviser at Montebello Avenue.
Even if inflation is currently rising more slowly than analysts predicted, it’s best to be prepared.
Financial advisors say one of the most consistent hedgers against inflation is a properly diversified stock portfolio.
Stocks have historically outperformed inflation, says Sean C. Gillespie, a financial planner at Redeployment Wealth Strategies. He says that while there is inherent volatility in a stock portfolio, “stocks are a long-term asset to your plan, just as inflation is long-term threat.”
To figure out where to put your money in the stock market, investors could look to an equity-based total return strategy 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 returns have not outpaced inflation,” says Dejan Ilijevski, investment adviser at Sabela Capital Markets. “Although some investors may assume that higher inflation leads to lower stock returns, U.S. market history shows that nominal annual stock returns are unrelated to inflation.”
Gold and commodities
Gold and commodities have been standard havens since inflation for investors.
“Traditionally, commodities and gold have been good hedgers of inflation,” says Stephanie Bucko, chartered financial analyst and co-founder of Mana Financial Life Design. But he says it’s important to consider the strength of the US dollar as part of that equation.
“We like exposure to oil because it affects our clients on a daily basis related to gas prices, but it also provides a good hedge against inflation,” says Bucko, adding that we saw this in the 1970s as the inflation doubled and nominal oil prices soared.
But commodity markets, for the uninitiated, can be complicated and risky.
“Commodities are volatile, more so than stocks, which means that adding commodities to a portfolio can increase the real volatility of returns, offsetting the benefits of hedging,” says Ilijevski.
Real estate is the ultimate hard asset in times of inflation as it will see price appreciation. Financial advisors recommend that investors find a position 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 good investment, Crawford says. “But I will caution that if you’re not raising the rent on your real estate, you’re not fighting inflation.”
Short-term bonds and TIPS
Short-term bonds and Treasury inflation-protected securities (TIPS) are investments that hedge against inflation.
“The hedge seeks asset classes that tend to be positively correlated with inflation,” says Ilijevski.
For example, he says, shorter maturities allow bondholders to transfer capital more often at higher interest rates. This helps inflation-sensitive investors keep pace with short-term inflation.
Similarly, TIPS, issued by the government, are also a fixed income safety hedge against inflation. Their principle is adjusted to reflect changes in the Consumer Price Index. When the CPI increases, the principle increases, resulting in higher interest payments.
“TIPS absolutely deserve a place in the portfolio of US investors, especially those with significant bond holdings,” says Crawford. “The main issue is that they are increasing in value in tandem with the CPI, which many would argue is not an accurate measure of inflation.”
