While high inflation hasn’t been a major concern for US consumers this year, it’s still important to consider the impact of inflation on your investment portfolio. Inflation not only affects your current purchasing power, but it can also eat into your investment returns and erode your wealth. So, what should you invest in during times of high inflation? Let’s explore some options.
Protecting Your Portfolio with the Right Investments
There are various ways to protect your investment portfolio from the effects of high inflation. Younger investors may benefit from maintaining a significant allocation to stocks, as they have a longer time horizon to ride out market fluctuations. On the other hand, retirees and those nearing retirement may need to seek out inflation protection in fixed-income assets. Additionally, some investors may choose to hold cash as a hedge against inflation.
Inflation Bonds: High Yields with Drawbacks
One attractive option for investors looking for a direct hedge against inflation is buying inflation bonds, also known as I bonds. These Treasury bonds offer monthly interest that combines a fixed rate and the rate of inflation, which adjusts twice a year. As inflation increases, so do the yields. I bonds issued between May and November 2024 yield 4.28%.
While I bonds provide a safe hedge against inflation, they do have some drawbacks. One major limitation is the purchase limit of $10,000 per year, which may restrict larger investors. Additionally, I bonds lack liquidity, as they only pay out when they are sold, typically after 12 months or upon maturity, which occurs 30 years after issuance.
Mutual Funds and ETFs: Hedging Against Inflation
Morningstar analysts recommend considering two areas for direct inflation hedging: Treasury Inflation-Protected Securities (TIPS) and commodities. TIPS funds provide a straightforward hedge against inflation, with the underlying bond values adjusting as inflation rises and falls. However, TIPS typically have lower yields, around 2% or less.
Commodities funds offer another avenue for inflation protection. Commodities prices, which are often sensitive to economic growth, play a significant role in inflation. By investing in commodities funds, you can capture potential spikes in commodities prices that precede inflation increases. However, it’s important to note that commodities prices can be volatile and difficult to predict, so Morningstar suggests keeping positions in commodities funds small.
Here are some recommended TIPS and commodities funds for high inflation:
- Vanguard Short-Term Inflation-Protected Securities Index (VTAPX)
- Vanguard Short-Term Inflation-Protected Securities ETF (VTIP)
- Schwab U.S. TIPS ETF (SCHP)
- Pimco CommoditiesPLUS Strategy (PCLIX)
Gold: Is It a Reliable Inflation Hedge?
Contrary to popular belief, gold hasn’t consistently proven to be a reliable investment for periods of high inflation. Like other commodities, the value of gold is unpredictable, making it difficult to determine its worth or future price movements. Investing in gold is essentially a gamble, as returns are random, and timing the market is incredibly challenging. Therefore, investors seeking consistent inflation protection may want to explore alternative options.
Stocks: Resilience and Long-Term Potential
While equities may not be a reliable short-term inflation hedge, they tend to be more resilient in the long run. Many companies have the power to raise prices and pass on higher supply chain costs to consumers. Additionally, some companies are not heavily reliant on raw materials costs to maintain their profit margins. However, it’s essential to select high-quality companies that can weather inflation, as the impact of inflation on the stock market can vary.
Morningstar analysts have identified several stocks of high-quality companies trading at discounted prices. These companies also pay consistent dividends, indicating strong balance sheets. Some of these stocks include:
- Duke Energy (DUK)
- Pfizer (PFE)
- Truist Financial (TFC)
- U.S. Bancorp (USB)
- Verizon Communications (VZ)
No One-Size-Fits-All Approach
It’s important to note that the investment options mentioned in this article are not the only inflation hedges available. Some investors may consider borrowing money to invest in real estate as a strategy to repay the debt with inflated dollars. However, there is no one-size-fits-all approach to investing during high inflation. The impact of inflation will vary depending on your portfolio composition and goals.
Investors should take a holistic approach to portfolio construction, considering potential risks and specific goals. While protecting against inflation is important, it should not dominate the entire portfolio. Balancing various investment strategies will generally lead to better outcomes. As Morningstar’s Russ Kinnel advises, “You don’t want inflation protection to dominate your portfolio.”
Remember, high inflation is just one factor that can affect your portfolio. By considering a range of factors and maintaining a diversified portfolio, you can position yourself for success in any market environment.
This article was originally published on Jan. 17, 2023.
