Inflation is a broad, sustained trend of soaring prices that has long been an essential part of investors’ lives. You hear about price increases in the news, you see them at the markets, and you may have thought of what it means for your investments.
Many investors look to push their long-term purchasing power higher. Achieving that goal can be challenging when inflation is around.
Inflation can be tough on your investment returns. It has the potential to eat up your money’s and portfolio’s purchasing power, even if you continue generating positive returns year-over-year.
To keep a steady footing in the market, your investments need to keep pace with the rate of inflation to improve the real purchasing power. Here are five investments that have proven to be effective in helping investors fend off inflation.
Having a portfolio that holds multiple stocks is another excellent way to counter the impact of inflation.
And despite the recent substantial increases in price, investors still managed to fight off surging prices. For example, the S&P 500 gained more than 32%, with dividends reinvested, from November 2020 to November 2021, when inflation climbed nearly 5%.
It is not necessary for you to bet on individual stocks, which can be extremely risky and require thorough research. Instead, you can invest in an S&P 500 index fund or S&P 500 exchange-traded fund (ETF), which follows the main index’s performance and can offer considerably low costs.
Additionally, since these funds comprise numerous stocks, your portfolio instantly receives easy and low-priced diversification, helping curb the risk and the stress associated with portfolio management.
Still, keep in mind that you may incur a loss in the short term when investing in stocks. Furthermore, with stock index funds, you don’t exactly have a say in the companies the fund will invest in.
If you don’t want to invest in firms that would go against your morals, you can choose to put some of your money in environmental, social, and governance (ESG) funds instead.
Gold is the oldest and widely recognized hedge against inflation since its price in US dollars can be subject to change. Just avoid putting all your money into this precious yellow metal, as there are more things that you need to learn about investing in gold.
If you opted for physical gold, like coins or bullion, you need to consider the additional storage and insurance costs, as those will reduce your returns.
Gold-focused funds can significantly cut the costs associated with storing and insuring physical gold. But always keep in mind that its price is highly volatile, especially in the short term.
Moreover, it would help determine whether the fund you want to invest in follows the yellow metal’s price or companies running gold mining businesses. Both are ideal options, although there is a huge difference in the number of returns they can deliver.
Investors looking to hedge their holdings against inflation often bet on real estate. However, the size and unpredictable nature of the real estate market can make it pretty hard to consider this asset class in broad terms.
Research has shown that retail property is the best type of real estate to combat inflation. Meanwhile, the performances in apartment buildings and industrial properties were slightly behind retail properties.
The study took inflation growth, maintenance costs, and appreciation into account when determining which real estate did well in the long run.
Buying single-family houses can provide an inflation hedge. However, in real estate investing, the issue lies in the part where it involves considerable buy-ins and a range of financing and maintenance costs.
That is where real estate investment trusts (REITs) come into play. With REITs, investors can easily diversify their portfolios and take advantage of real estate’s inflation hedging capabilities.
Investing in REITs is similar to purchasing a fund holding real estate assets exclusively. They are an attractive investment avenue to many investors, particularly income investors, as official guidelines require them to pay dividends regularly.
Plus, REITs have historically performed well. In November of last year, data showed that the MSCI US REIT Index rose nearly 32% for 2021. While it has registered an average annual return of 10.9% over the past ten years.
Treasury Inflation-Protected Securities (TIPS)
Treasury Inflation-Protected Securities (TIPS) are mainly intended for protecting investments from surging prices.
The US Treasury sells TIPS and increases (inflation) or lowers (deflation) their par value – principal – every year. The move raises investors’ interest payments and the odds of seeing some appreciation from the change.
TIPS appeal to investors due to its protection against inflation. Still, it’s important to note that they can only maintain your money’s purchasing power. Moreover, driving growth is not strictly part of their job.
Moreover, you need to be prepared for deflation when investing in TIPS. While there’s hardly a chance that you’ll receive less than the TIPS’ actual principal value once it matures, its value can still fall while you’re receiving interest payments.
Series I Bonds
Series I savings or I bonds are another investment option you can bet on to keep up with inflation. Similar to TIPS, I bonds are government-issued. Their security is designed to keep purchasing power by regularly adjusting interest based on current inflation.
Where these two differ is with the par value. I bonds don’t make changes on your bond’s par value. Instead, they adjust interest rates every six months according to the prevailing inflation. That can be excellent these days, as interest rates are above 7% until at least April this year.
However, the interest rates of I bonds constantly change and can even reach zero. So while it’s certain that you will not lose your initial investment, inflation can still eat into it over time if interest rates drop.
Furthermore, I bonds’ lock-in dates are quite heavy. You can cash out an I bond after a year, but if you cash it out before five years, you lose three months’ worth of interest as a penalty, similar to a certificate of deposit (CD).