Tips on Hedging Against High Inflation
When planning for your future financial needs, several factors come into play, including your evolving requirements, future goals, health, age, and personal situation. Another critical aspect to consider is inflation. Inflation erodes the value of your savings as the prices of goods and services increase. The rate of inflation was at a record high of 4.1% in 2023. While the anticipated 2% to 3% is considered good for the economy, any higher than this can be a cause of concern. This makes it essential to incorporate strategies that protect your investments from the impact of inflation.
A financial advisor can guide you in identifying the best investments to hedge against inflation. This article will also identify effective ways to invest to protect against high inflation to ensure financial stability in the long run.
Table of Contents
Below are some investment instruments that can provide inflation-beating returns and help protect your money from high inflation:
1. Government-backed bonds like the Treasury Inflation-Protected Securities (TIPS) and floating-rate bonds
Bonds, like TIPS, can be a useful tool to beat inflation. While not all bonds offer this advantage, TIPS are government bonds that are specifically designed to follow and mimic the rate of inflation in the country. Because they are indexed to inflation, they help you grow your portfolio without losing value to rising prices. The interest rate on TIPS increases when inflation is high and decreases when inflation is low. This characteristic makes them the perfect investment during high inflationary environments. If you anticipate high inflation in the future, investing in TIPS can be ideal. TIPS are issued in varying maturity periods ranging between 5, 10, and 30 years and deliver returns semi-annually, ensuring you have a regular stream of income. Another significant benefit of investing in TIPS is that they are backed by the U.S. government. This means that the return of the principal is guaranteed, making TIPS an attractive option for risk-averse investors.
Including TIPS in your investment strategy can stabilize the risk in your overall portfolio by preserving the purchasing power of your investment. This is particularly beneficial for long-term investors as it helps maintain the value of your money over time.
Additionally, you can also consider floating rate bonds. Floating rate bonds adjust their returns according to benchmark interest rates. When inflation is high, interest rates usually increase, so the payouts from these bonds are higher, providing you with protection against inflation. One example of a floating rate bond is the Series I bond. These bonds are backed by the government and offer a level of safety similar to TIPS while providing inflation protection.
2. Stocks
Investing in stocks can provide inflation-beating returns when you invest for the long run. Over the past 95 years, the average stock market returns have been 12.3% per year. In fact, stocks can be one of the best investments during inflation and recession. Even during a recession, some companies, particularly blue-chip companies or those with steady business models such as basic consumer goods and defense stocks, can hold their ground. By investing in them, you can reduce some of the risks associated with inflation and recession and enjoy a combination of stability and potential growth.
However, when investing in stocks, you must understand that stocks can be volatile, which is why long-term investment is essential. The good thing about investing in stocks is that you can do so in multiple ways. You can add stocks to your 401(k) or Individual Retirement Account (IRA), which can offer tax advantages and help you grow your retirement savings. You can also invest in them directly through brokerage accounts for better control over your investment choices. However, this requires some prior knowledge of the stock market, as you would have to make investment decisions all by yourself. Additionally, you can invest in equity mutual funds, where a fund manager invests on your behalf. This can be a good option if you prefer a hands-off approach, as the manager will be the one to make buying and selling decisions for you.
The most important thing to remember is that your stock portfolio should be diversified. Diversification will lower the risk and amplify returns, ensuring your chances of earning are increased. Over time, this can lead to better overall returns. You can achieve diversification by investing in stocks from multiple market caps, sectors, and geographies. This means including small, medium, and large-cap companies in your portfolio. Investing across various sectors, such as technology, healthcare, tourism, energy, finance, and consumer goods, among others, can help spread the risk. Additionally, including both domestic and international companies in your portfolio can offer protection from the political and market downturns of a specific country. Spreading your investments across different types of stocks and sectors helps reduce the risk of a single poor-performing investment significantly impacting your overall portfolio. This is because you can rely on others if one stock does not perform well. For instance, if the energy sector is experiencing a downturn, other sectors like healthcare or consumer goods might perform well, balancing your overall returns.
3. Real estate
Real estate can be one of the best investments against inflation. As a commodity, real estate tends to increase in value when inflation rises. Property values and rent rates typically increase when prices rise, making real estate a viable option to combat inflation. Not only does inflation lead to capital appreciation, helping you fetch a high return when you sell the property, but it also allows you to increase rent rates and boost your passive income.
Over time, real estate prices generally appreciate as demand for property increases. This means that with or without inflation, real estate can be a good asset. Unlike other investment options, real estate is a tangible asset. You can use it as collateral, rent out part of it while continuing to live in it, or even pass it on to future generations. These characteristics make real estate a versatile option to tackle multiple financial situations.
However, investing in real estate does have some drawbacks. Liquidating real estate can be challenging, as finding buyers can be difficult. Additionally, realtor commissions can be an expense to factor in when selling a property. The high investment values associated with real estate can also be a barrier, making it difficult for many investors to invest in real estate in the first place. Moreover, the location plays a critical role in real estate prices. It is important to invest in an area that has the potential to grow or be in demand over the long term. One solution to these challenges is Real Estate Investment Trusts (REITs). REITs are pooled funds that invest in commercial and residential properties, such as residential houses, malls, and other commercial spaces. They offer a lower investment threshold while providing returns linked to the real estate market. This makes REITs an accessible option for investors looking to benefit from real estate without the high costs and complexities of direct property ownership.
Investing in real estate can be a powerful strategy to protect against inflation and build long-term wealth, but it requires careful planning. It is important to discuss these aspects with a financial advisor and real estate agent first. They can provide tailored advice based on your financial situation, investment budget, and future goals.
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4. Precious metals
Investing in precious metals like gold, silver, and others is another effective strategy to hedge against inflation. These assets tend to increase in value when inflation rises, helping you earn more during inflationary periods. Inflation is not the only factor affecting their prices. Demand and supply also play a significant role. However, precious metals have historically been used as a hedge against inflation and for portfolio diversification.
Moreover, precious metals have a high resale value, which makes them a reliable asset to liquidate for returns when needed. Unlike real estate, which can be hard to liquidate, precious metals like gold and others can be bought or sold easily. They are also highly versatile, allowing you to invest in them in various forms, such as gold or silver bullion, jewelry, or virtually through mutual funds and Exchange-Traded Funds (ETFs). The benefits remain largely the same whether you choose physical or virtual investments. Gold bullion or coins provide a tangible asset that you can store securely and sell when the market conditions are favorable. Jewelry not only serves as an investment but can also be worn or gifted to evade estate taxes in the future. Lastly, mutual funds and ETFs that invest in precious metals offer a convenient and highly liquid way to invest in this asset class without the need for physical storage.
It is also important to know what investments should be avoided during inflation. Here are some of them:
a. Cash
Cash eliminates the potential to earn more on your money as it remains idle and eventually loses its value due to inflation. Therefore, cash deposits should be avoided if you are trying to protect your money against inflation. If you keep your money in a bank or store cash at home, it will decline in value in the long term. While bank accounts may offer some returns through interest, these are typically negligible over the long term.
Instead, you might consider high-yield savings accounts. These accounts offer higher interest rates compared to regular savings accounts and provide better growth for your money. High-yield savings accounts are also a good option for maintaining an emergency fund, as they are highly liquid and provide easy access to your funds when needed. With high-yield savings accounts, you can earn more interest on your savings while still keeping your money safe and easily accessible. This helps to mitigate the effects of inflation on your cash holdings and ensures that your emergency fund is earning as much as possible.
b. Long-term fixed-income investments like long-term bonds
Investing in long-term fixed-income investments like long-term bonds can lead to losses in the long run. The fixed interest rates from such investments over the long term do not account for the rising impact of inflation. This means that your returns will not always keep pace with inflation. During inflationary periods, when prices increase, your returns may actually be lower in real terms, leading to a loss rather than a profit. Therefore, locking away too much of your money into lower interest rates for an extended period can be detrimental. While long-term bonds can provide stability and predictable income, their returns can be eroded by inflation over time. This makes them less effective in protecting your wealth during inflationary periods.
If you do choose to invest in long-term bonds for overall portfolio diversification and stability, it is wise to keep the concentration low. This ensures that your overall gains are not significantly impacted by the lower real returns these bonds may offer during periods of high inflation. Ultimately, maintaining a balanced portfolio that includes a mix of different asset types, including the ones mentioned above, can better protect your investments against the negative effects of inflation while still benefiting from the stability that long-term bonds can provide.
To conclude
Inflation can erode the purchasing power of your money over time, so investing in assets that can grow in value faster than inflation is crucial. However, it is equally important to diversify your portfolio across different asset classes. Long-term gains are not only impacted by inflation but also by other economic factors such as interest rates, market conditions, and geopolitical events. Diversification can help spread these risks and reduce the impact of volatility on your overall portfolio. Each of the assets mentioned above reacts differently to economic conditions, so keeping a mix of them can provide you with a balanced approach to growth and protection against inflation. Hiring a financial advisor can also be instrumental in selecting the best investments against inflation based on your financial goals, risk tolerance, and time horizon.
Use the free advisor match tool to get matched with seasoned financial advisors who can help you employ appropriate inflation-protection measures and ensure that your portfolio remains robust against rising prices. Answer some simple questions about your financial needs and get matched with 2 to 3 advisors who can best fulfill your financial requirements.
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