1. Gold and Silver
2. Real Estate
3. Commodities
4. Value Stocks
5. REIT Funds
6. Stock Index Funds
7. Floating-Rate Loans
8. Inflation-linked bonds
Bottom Line:
Is inflation coming? The current surge in prices and commodities is affecting many countries around the globe. As investors begin to react to the inflationary environment, many have started to look at how to hedge against inflation. This article explores the best inflation investments you can add to your portfolio.
Top experts and investors are reeling from / feeling the effects of inflation. The U.S. stock market has steadily dropped, with investors fearing a possible recession. The outlook of the Chinese economy doesn’t seem very encouraging as Covid lockdowns continue to disrupt businesses.
This year, the market cap for cryptocurrencies has also dropped, adversely affecting Bitcoin, often recommended as a potential inflation hedge.
With various asset classes available, it may be difficult to pinpoint which ones are your best bets for outpacing the inflation rate. Let us make the decision easier for you with this article, recommending what to invest in during inflation and explaining the benefits and risks involved in each asset.
Read through the end of this article to learn how to protect against inflation and how to profit from it by choosing the right assets for your portfolio. But first, let’s start with a historically proven investment in times of crisis.
1. Gold and Silver
Investing in gold and silver could help hedge against inflation. Both metals have made solid gains as U.S. markets rose due to inflation. Gold and silver are valued in U.S. dollars, which gives them an advantage when the U.S. dollar falls in value. These metals become less expensive to buy with other currencies.
Like wars and other adversity, historical conflicts consistently drove the price of gold higher as currencies devalued. If the geopolitical tensions we experience today worsen, tying your wealth to your nation’s currency makes it vulnerable to inflation.
Of course, this leads to the question of whether to invest in gold or silver. Due to industrial demand, silver has historically risen higher during inflation. You can physically or indirectly purchase these assets through an exchange-traded fund (ETF).
2. Real Estate
Certain physical assets offer one of the best investments for inflation protection. Investor Warren Buffett once cited that a toll bridge would be his favorite thing to own in an inflationary world because you would have already built the bridge and could raise prices to offset inflation.
While it may be absurd to buy a toll bridge yourself, Buffet’s advice still stands where the real property is concerned. Buying real estate is a good opportunity to hedge against rising inflation. Once you own a property, you can lease it or rent it as housing market prices continue to rise and catch a windfall from it.
Investing in property leases or rentals earns you income – the amount of which could very well exceed overheads and payables, depending on your property’s location. If your property is in a desirable or prime location, you could benefit from increasing rent prices.
It’s also important to find mortgages with a fixed interest rate, which ensures each regular payment is based on the dollar price when your mortgage started. As inflation rises, the amount of the monthly amortization you need to pay decreases.
Let’s take a look at how a fixed-interest mortgage helps hedge against inflation. Suppose your mortgage payment is US$ 10,000. Currently, that amount could pay for 30 months of groceries. In 20 years, your mortgage payment will still be US$ 10,000, but that amount may cover only 8 months of groceries in the future.
In an inflationary environment, property owners could profit in the future as housing prices continue to appreciate. This makes owning real estate one of the best inflation investments if you have the capital for it.
3. Commodities
The price of commodities, such as gas, has hit record highs globally. Russia’s invasion of Ukraine caused the price of oil to spike as countries agreed to put sanctions on the Russian economy. A price hike in oil also affects the global supply chain, the airline industry, and even consumer spending. Are these investment assets a good buy during inflation?
Commodities like precious metals, industrial metals, and oil are usually the strongest performers during rising inflation. Commodities generally do not correlate with the stock market, which could be useful for stock investors looking to diversify.
Crude oil, in particular, has exhibited the highest correlation with the Consumer Price Index or CPI. It has also become the most invested commodity through ETPs outside of gold and silver.
In 2021, commodity products accumulated an inflow of over US$ 6 billion. Many investors wanting to get into these commodities purchased futures — contracts where the investor agrees to buy or sell a predetermined amount of a certain commodity at a specific price on a specific date in the future.
While the opportunity for earning a profit through commodity futures is certainly possible, it has historically been outperformed by investments on broad commodity indexes such as the S&P GSCI index.
Opportunities may arise depending on which commodity you research. For example, the price of steel in 2021 dramatically increased due to reduced supply during the pandemic.
4. Value Stocks
How does inflation affect stocks? While it is not a simple question to answer, we can broadly predict how the stock market could behave when inflation hits.
Stocks can be categorized into two types: value and growth. Value stocks are companies currently trading below their worth and typically come from certain sectors, such as the industrial, financial, and energy sectors. Growth stocks are usually from the technology sector or consumer discretionary goods and services.
Buying value stocks while their prices are low could be a good inflation hedge, especially if the prospective company benefits from an inflationary economy. In an exchange with MicroStrategy CEO Michael Saylor, Elon Musk stated that it is good to invest in stocks in the companies you think make good products rather than in dollars when inflation is high.
Utility stocks tend to outperform other sectors in providing a hedge against inflation among the value stock sectors. Utility stocks are also likely to pay dividends and are less susceptible to market volatility.
Many value stocks tend to benefit from higher inflation compared to growth stocks. Value stocks typically have strong cash flows that may diminish over time. As they stand, the interest rates of growth stocks make them more vulnerable to the negative impacts of rising interest rates.
Value stocks usually trade at US$ 50 or US$ 60 a share in the U.S. market but are worth at least twice that amount. Top U.S. hedge funds have started to shift focus to value stocks as inflation slows down the cash flows of speculative growth stocks.
5. REIT Funds
Real estate investment trusts or REITs are companies that own or finance income-producing real estate across various sectors. REITs buy and develop properties primarily to operate them as part of their investment portfolio and not to resell. These investment trusts allow investors to include real estate in their portfolios without purchasing any real estate of their own.
Much like actual real estate, REIT funds offer similar protections against inflation. REIT dividends have outpaced inflation metrics such as the Consumer Price Index.
Since REITs are based on real assets, the value of your REIT investment will likely increase as overall price levels continue to rise. REIT funds offer one of the best investments during inflation primarily due to the ability of these trusts to increase rent and lease payments as consumer prices increase.
Property values tend to increase during inflation despite rent control, which fundamentally makes REIT funds one of the more solid inflation investments against even moderate increases in inflation.
6. Stock Index Funds
Investors seeking how to hedge against inflation can consider index funds over individual stocks. Index funds are a portfolio of stocks or bonds that mirrors the performance of a particular market index. They are one of the simplest ways to gain exposure in an investment market.
When you buy an index fund, you effectively buy a small portion of several securities, readily giving you the advantage of diversification essential to a portfolio aiming to beat inflation.
Compared to investing in a single stock, index funds give you a certain amount of security. When the stock market crash during inflation, we never know where is the bottom. If you’re looking to “buy the dip” or even “short sell” the stock index in a bearish stock market, you can allocate funds to an index fund such as the S&P 500. This strategy is more likely to give good returns during the bear market caused by inflation.
Depending on the sectors the index focuses on, index funds can be considered one of the best inflation hedges in 2022.
7. Floating-Rate Loans
Floating-rate loans are a type of debt financing normally negotiated between a group of banks and a corporation. Unlike traditional bonds, these floating-rate loans are subject to variable interest rates. These bonds can respond to changes in short-term interest rates and make loan prices less sensitive to inflation.
As the interest rates continue to rise, a floating rate loan can hold its value against inflation better than a fixed-income bond.
However, floating-rate loans still come with some risks despite their advantages. For instance, floating-rate loans have greater credit risk than investment-grade bonds because many companies availing of these loans tend to have lower credit quality. Consequently, floating-rate loans have a higher probability of defaulting in the future.
8. Inflation-linked bonds
The graph above shows the example of the inflation-linked bonds usually linked to main inflation measures
Investors can benefit from knowing how to prepare for inflation through inflation-linked bonds. ILBs are a type of bond which increases in value during inflationary periods. These bonds have their principal and interest payments linked to inflation measures, such as the Consumer Price Index in the U.S. or the Retail Price Index in the U.K.
Increases in price levels in the market will positively affect the value of the principal. While traditional asset classes, such as stocks, are adversely affected during inflation, ILBs provide an effective way to expose your portfolio to assets that are directly tied to an inflation index.
One risk ILBs have is that the principal amount may decline below its par value in the event of deflation. However, many countries offer deflation floors at maturity to ensure the investor receives full par value even if deflation drags the principal value down.
Aside from ILBs, investors can also research aggregate bond index funds as a potential hedge against inflation. These index funds cover all types of bonds, including government and corporate.
For example, various ETFs and mutual funds track the Bloomberg Aggregate Bond Index, which captures the performance of the U.S. investment-grade bond market.
Bottom Line:
Who benefits from inflation? While inflation negatively affects consumers, it offers investors an opportunity to earn and profit. For instance, owning real estate during inflation allows you to adjust your rental income to counterbalance or beat inflation rates. Banks and mortgage companies also benefit from increased interest rates resulting from inflation.
It’s always helpful to understand the effects of inflation on your portfolio as the first defense against possible damages you could sustain otherwise. Ensure you know the investment hedge options to help you brace your portfolio against any adverse consequences before inflation dramatically decreases your purchasing power.
Suppose you’re a first-time investor looking to learn how to hedge against inflation. In that case, you can start with lower-risk options, like bonds and index funds that capture sectors such as energy and consumer staples. If you are a more experienced investor, consider researching specific values stock opportunities or real estate options in prime locations.
While there is no such thing as inflation-proof investments, you can mitigate risk by making smart choices to allocate and diversify your funds in an inflationary period.
