If your trips to the grocery store and gas station seem to be more expensive than usual, that’s because they probably are.
According to the Board of Governors of the Federal Reserve, inflation is up by 7.5% — the highest it’s been in four decades.
Christopher J. Waller, a member of the Board of Governors of the Federal Reserve, said in a statement, that the increase in prices (aka inflation) is a result of “supply bottlenecks, and labor shortages, some of them related to the pandemic.”
Like many people, I manage my investments because it’s cheaper. And, so, I made the rookie mistake of not taking inflation into account when I was building my IRA portfolio.
This, my friends, led to some massive dips in the last few weeks.
Needless to say, I need to fix this. So, I talked to Doug Carey, president and founder of WealthTrace, a financial and retirement planning software company, to see if there’s a way I can inflation-proof my portfolio. Here’s what he told me.
Why you should care about inflation when building your investment portfolio
Before we get into the good stuff (aka how to pick investments that will perform well even if there’s inflation), first, it’s important to understand the relationship between inflation and your portfolio.
Inflation occurs when the price of consumer goods and services increases to the point that it substantially reduces how much you can purchase with each dollar.
To give you some context, the Federal Reserve says that an “acceptable” inflation rate is about 2%. If it’s more than that, your finances will suffer big time.
But what does that have to do with your portfolio?
Well, Carey says that inflation basically “eats away your portfolio,” if your investments aren’t keeping up with the pace.
“For example, anybody who had $10,000 in a bank account for the last year, earning 0% interest — which most do — just lost 7.5% of that money, not physically, but in purchasing power. So, they just lost $750, and it’s never going to return.”
In other words, if your investments aren’t earning a higher interest than the current rate of inflation, you’re essentially losing money on your portfolio.
6 types of investments that can hedge against inflation
While there isn’t a perfect way to build a portfolio that’s 100% inflation-proof, there are certain investments that can help you mitigate losses, and even profit from the circumstance. These are some of them.
Value stocks, especially those that belong to companies that sell essential items
Carey says that a lot of people seem surprised when he recommends stocks, since they tend to sink a bit during high inflationary periods. But he says that what a lot of people overlook, is that some value stocks actually benefit from high inflation.
Value stocks are those that can be bought for a relatively cheap price compared to what their future value will be.
Read more: The Beginner’s Guide To Value Investing
When purchasing value stocks, Carey recommends going for those tied to companies that sell consumer staples, or things that you need regularly (no, wine doesn’t count — we’re talking about toothpaste, toilet paper, and things like that).
“These companies sell all these things that people pretty much have to buy, right?” Carey says. “It’s not luxury items. It’s the opposite of that. So their revenues will go up, and stock prices will keep up with inflation.”
Some examples of value stocks from companies that sell basic goods include:
- Clorox (CLX).
- Nestle SA (NSRGY).
- Costco Wholesale Corp (COST).
- L’Oreal SA (LRLCY).
- Kroger (KR).
- Target Corp (TGT).
- Procter and Gamble Co (PG).
Besides buying the company’s stock, you can also invest in these companies through exchange-traded mutual funds (ETFs), such as the iShares U.S. Consumer Staples ETF, or the Vanguard Consumer Staples ETF. If you don’t know how to invest in ETFs, here’s our quick guide to help you out.
I savings bonds
“Many investors don’t even know these bonds exist, but they are one of the best investments that exist for hedging against inflation.”
Let’s unpack that.
In case you’ve never heard of I savings bonds either, they are debt securities issued by the U.S. Department of Treasury, just like traditional bonds. The difference, however, is that their interest is a combination of a fixed rate, plus the current rate of inflation (hence the “I” in their name).
I savings bonds earn interest for up to 30 years, and they currently have a combined interest rate of 7.12%, according to TreasuryDirect.gov.
The best part about these bonds is that the interest is fixed. So, if you purchase them today, you’d keep earning 7.12% on interest, even if inflation goes down in a month or two. Besides that, they are exempt from state and local taxes, which allows you to maximize your earnings.
The only major caveat is that you have to wait at least a year to cash them.
Treasury inflation-protected securities (TIPS)
Just like I bonds, treasury inflation-protected securities, or TIPS are a type of treasury bond designed to help investors protect themselves against rising inflation.
But, unlike I bonds — which earn interest based on the current inflation rate — when you purchase TIPS, the inflation rate is added to your principal balance instead, and you earn interest on that amount. Additionally, you get paid interest on a semiannual basis.
Let’s look at an example of how this would work:
Let’s say you buy $1,000 on TIPS earning 1% on interest. With the current rate of inflation, which is 7.5%, your principal would be adjusted to $1,075. That means you’d get a payment of $10.75 every six months, if inflation stays at 7.5%.
If you’re wondering how the interest rate is determined on these types of bonds, they are set at the time they’re auctioned (aka sold). TIPS require a minimum purchase of $100, and have maturity periods of 5, 10, and 30 years.
The only major downside of owning TIPS is that if there’s deflation, you’ll earn less on interest.
You can purchase them electronically on TreasuryDirect.gov, or through a bank, broker, or authorized dealer.
Real estate investment trusts (REITs)
The relationship between real estate and inflation is quite simple: if inflation is high, property values go up, and so does rent (typically).
One of the best ways to invest in real estate is through a real estate investment trust, or REIT.
A real estate investment trust is a company that owns, and sometimes operates different types of income-producing properties. These can be apartment buildings, commercial real estate, hospitals, etc.
Carey says that:
“theoretically, they’re a good hedge against inflation, but the average investor probably should be wary because with REITs you need to analyze them a lot more before you invest.”
Because some of these companies also are in the business of financing properties, and if inflation goes up, so will the cost of lending, which can eat a chunk of your earnings.
Another thing to take into account is that anything you earn with a REIT will be taxed as ordinary income up to a 37% rate.
You can add these to your investment portfolio in the form of stocks, just like you would with any other public company, but you can also invest in them through ETFs or mutual funds.
Commodities are an asset class that consists of raw materials, or agricultural goods that can be bought and sold in bulk, and are essential to human activity.
Some examples of commodities include:
- Dairy products.
- Precious metals.
- Natural gas.
When it comes to protecting yourself against inflation, Carey says that both gold and anything energy-related are your best bets, as they tend to retain, and gain the most value.
“During the 1970s when the U.S. had its last battle with serious inflation, the price of gold increased by 560%,” Carey says. “Oil stocks have also done really well. During the last year, Exxon was up probably 75% or something like that.”
You can invest in commodities in the form of stocks, ETFs, mutual funds, as well as through exchange-traded notes (ETNs).
Read more: How To Invest In Commodities
Before you come at me, let me state the following: this one is still up for debate.
For example, in Carey’s opinion, crypto is one of the most dangerous investments to hedge against inflation due to its volatility, which is why he urged me to put it at the bottom of the list (I obliged).
But many investors argue that because some cryptocurrencies, like Bitcoin, have a limited supply, this scarcity makes them a valuable asset to hedge against inflation.
If you’re interested in adding cryptocurrencies as part of your assets, one smart way to use them against inflation is by staking coins.
Staking is a process by which you earn interest for holding certain cryptocurrencies.
In other words, it’s like a savings account for crypto. The main difference is that staking tends to offer higher interest rates than most savings accounts do.
One of the best platforms for crypto staking is Celsius. Besides offering higher-than-average interest rates, Celsius offers a wide range of cryptocurrencies, some even attached to fiat currencies, like the U.S. dollar, and gold. You can check each coin’s yield rates here.
When it comes to inflation, the bottom line is that there isn’t a perfect way to beat it. However, adding some of these assets as part of your portfolio can help you hedge against it.
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