5 best investments that protect against inflation and others to avoid
Investors seem increasingly worried about the risk of spike in inflation during the post-pandemic recovery, as the stock market cooled somewhat after its scorching rally earlier in the year. This might be a good time to reassess your portfolio and decide whether and how best to hedge your investments against the possibility of a price hike in the near future.
Here are five of the best inflation hedges to help protect your portfolio against inflation, and two areas you want to avoid if you see sustained inflation on the horizon.
5 Ways Investors Can Stay Protected Against Inflation
The government has injected billions of dollars into the economy through deficit spending and stimulus measures since the start of the COVID-19 pandemic. Meanwhile, the Federal Reserve cut interest rates to near zero and is committed to keeping them there until 2023, and even said he would let inflation overtake the short-term trend.
Sustained inflation would likely lead to higher interest rates, so investors should consider how best to position their portfolios if this happens. That said, the economy spent much of the 2010s without high and sustained inflation despite huge budget deficits and low interest rates.
If you’re expecting inflation to rise, this might actually be a good time to be a borrower, if you can avoid being directly exposed to that inflation. The reason? If you borrow at a fixed interest rate, you are effectively paying off your debt with cheaper dollars in the future. This can get even better if you use certain types of debt to invest in assets that are likely to appreciate over time, such as real estate.
Here are some of the top inflation hedges that can help you mitigate the impact of inflation.
TIPS, or Inflation-Protected Treasury Securities, are a useful way to protect your investment in government bonds if you expect inflation to accelerate. These US government bonds are indexed to inflation, so if inflation rises (or falls) so will the effective interest rate paid on TIPS.
TIPS bonds pay interest every six months and are issued with maturities of 5, 10 and 30 years. Because they are backed by the US federal government (like other public debts), they are considered one of the safest investments in the world.
2. Variable rate bonds
Bonds generally offer a fixed payment for the life of the bond, which means bonds have their large side exposed to rising inflation. One way to mitigate this effect, however, is to use a floating rate bond, where the payment increases in response to rising interest rates caused by rising inflation.
One way to buy them is through ETFs or mutual funds, which usually have a large assortment of these bonds. So, in addition to inflation protection, you will also benefit from some diversification, which means that your portfolio may benefit from lower risk.
3. A house
You might not think of a home as a good way to protect yourself against inflation, but if you’re using a mortgage to buy your home, it can be a great way to do it. With a long-term mortgage – at rates close to historically low levels – you’ll have cheap financing for up to three decades.
A fixed rate mortgage allows you to keep most of your housing expenses on the same payment. Sure, property taxes will go up and other expenses might go up, but your monthly housing payment remains the same. This is certainly not the case if you are a tenant.
And, of course, by owning a home, you will have the potential to increase its value over time. If more money is flooding the market, you may also get price appreciation.
Stocks are a good long-term vehicle to hedge against inflation, although they can be hit by anxious short-term investors as their worries increase. But not all stocks are equally good hedges against inflation. You’ll want to look for companies that have pricing power, so that as their own costs rise, they can increase their customers’ prices or even charge more for their products.
And as a company’s profits increase over time, its stock price is expected to rise. While the stock market can be affected by fears of inflation, the best companies do it because of their better economics.
Gold has traditionally been a safe haven for investors when inflation rises or interest rates are very low. Gold tends to do well when real interest rates – that is, the reported interest rate minus the rate of inflation – go into negative territory. Investors often view gold as a store of value during difficult economic times, and it has been successful in achieving this goal over long periods of time.
A good option for investing in gold is to buy it through an ETF, so that you won’t have to own and protect the gold yourself. Additionally, you have several options with ETFs, allowing you to own physical gold or the shares of gold miners, which can offer a bigger upside if gold prices skyrocket.
Inflation can hit both types of assets hard
1. Long-term bonds
Long-term bonds can be completely destroyed if inflation rises and investors expect it to persist for years. The reason is simple: if inflation exceeds the bond’s interest rate, you lose purchasing power over time. So the price of a long-term bond will drop to compensate for this. The longer the bond’s maturity, the more sensitive its price is to a change in inflation.
One of the longest maturities is for 30-year Treasury bonds, and it can move significantly in response to rate changes. If you own it and interest rates rise, you will suffer an immediate loss of your principal. When the bond matures, you will be able to receive all of your principal, but you may need to undergo decades of immersion in your investment.
Short-term bonds – those that mature in less than a few years – will feel little impact from a slight upturn in inflation.
2.Long-standing fixed rate CD
Like long-term bonds, long-term fixed rate CDs lose their appeal if inflation rises. Since the value of a CD’s fixed interest rate can be drastically eroded by inflation, you will lose purchasing power over time. Unlike long-term bonds, however, the principal value of your investment will not decrease, but it may cost you a penalty for breaking the CD, if you do.
If you like the security of bank-backed CDs, an alternative could be inflation-protected CDs, which adjust their effective interest rate up or down in response to changes in inflation.
At the end of the line
Rising inflation is a big concern for investors right now, but it remains to be seen whether high levels of inflation will persist or end up being due to ‘transient’ factors, as the Fed recently suggested. .
Either way, it makes sense for consumers to think about making some cash flow right now, like refinancing a mortgage into a fixed mortgage at historically low rates or paying off outstanding debt balances. adjustable rates. These are simple and relatively inexpensive measures that can help you profit from them even if inflation is not accelerating.
Investors, if they hold individual stocks, could assess which of their holdings is most exposed to inflation and consider reducing that exposure or perhaps not increasing the position further.
Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past performance of investment products is not a guarantee of future price appreciation.