Protecting Your Investment Portfolio from Inflation
From gas to groceries, prices have risen across the board over the last year with inflation reaching 8.6% in May 2022. But inflation not only makes things more expensive, it can also have a negative impact on your investment portfolio.
Aside from household goods and services, inflation affects stock prices, bond rates, and potential returns on equity. At the same time, it reduces your purchasing power, which means each dollar in your account is worth less and won’t stretch as far.
The good news is that there are ways to protect your investment portfolio from the forces of inflation. Here’s how savvy investors outpace inflation to ensure that their hard-earned savings continue to meet their needs for years into the future.
Alternative Investments as Inflation Hedges
Looking for a hedge against inflation? Now is the time to embrace the world of alternative investments. Alternative investments differ from traditional investment vehicles because they have a low correlation with the movements of the traditional stock market.
Real estate is one example, and some of the most common investment options in this sector include:
- Direct ownership (buying and renting out property to tenants)
- Indirect ownership through a real estate investment trust (REIT)
- Indirect ownership through a real estate investment group (REIG)
Real estate is a smart asset for investors who want to protect themselves against inflation, are looking to earn passive income, or want to diversify a fixed-income portfolio.
Or consider commodities, another type of alternative investment. Gold and other precious metals have been used for centuries to hedge against rising prices. These metals are tangible, scarce, and have historically shown to have a negative correlation to paper money. During periods of higher inflation, gold tends to hold or gain value better than other investments.
Aside from owning physical gold, consider accessing gold and other precious metal investments through an exchange-traded fund (ETF). Gold ETFs trade like any other stock, and you can invest using an online brokerage.
The prices of these commodities increase with inflation. They also act as indicators of future inflation along with economic growth. As the economy expands, the demand for gold, precious metals, and other commodities increases as well. In turn, prices can push higher.
Blue-chip art is seen as an inflation hedge that is less volatile than crypto and equities markets. In a worst-case scenario of high inflation causing a slowdown in consumer spending that affects stock market returns, real assets such as fine art historically retain their value.
The long-term nature of art as an investment also helps retain value as it does not generate cash flows subject to purchasing power declines. Similar to real estate or commodities, blue-chip art can either be purchased on its own or fractionally.
Diversify Your Portfolio
If you choose the right companies to invest in, using stocks to hedge against inflation can be quite effective. For example, it makes sense to invest in companies that can raise prices to stay on par with the rate of inflation. This helps them to maintain a stream of cash flow, which benefits your portfolio, especially if the company pays dividends to shareholders.
Buying defensive stocks is another smart play to protect your investment portfolio against inflation. Inflation often causes people to spend less on nonessential items. Defensive stocks represent goods and services that consumers must spend money on, such as energy, food, and household products. On the other hand, as inflation starts to ease, it’s better to switch to cyclical stocks.
Early on in a recession, defensive stocks often get a boost because people only buy the things they absolutely need. But as the recession and inflation ease, cyclical stocks, which are those that represent companies that offer discretionary goods and services, typically do very well.
If you want to look beyond domestic stock, check out international and emerging markets. When inflation is confined to a single economic ecosystem, it makes sense to invest globally. Top options include:
- Ex-US ETFs
- Ex-US Currencies
- Mutual funds
Diversifying your stocks helps to safeguard your portfolio in the event of an inflation driven market.
One of the most straightforward ways to inflation-proof your investment portfolio is to choose investments that are designed to protect against it. Treasury Inflation-Protected Securities (TIPs) are treasury bonds that are specifically designed to help investors storm the rising and falling inflation throughout the years.
TIPs principal is tied to changes in the Consumer Price Index (CPI), which analyzes and measures inflation. Inflation (increase in the CPI) causes TIPs’ principal to increase. It decreases with deflation (decline in the CPI).
TIPs pay a fixed rate of interest twice a year, with the amount based on the adjusted value of the principal.
Because TIPs are government-backed bonds, they’re one of the safest ways to prevent inflation from adversely impacting your portfolio. Whether inflation goes up or down, your risk of losing money is much lower.
While there are plenty of valid reasons to be concerned about during periods of inflation, there are several ways to harden your investment portfolio against inflation. Instead of letting fear take over, make the situation work for you. From TIPs to alternative investments, knowing how to protect your portfolio, especially during volatile times, will give you peace of mind and confidence. Make the right moves and you too can weather the storm.