Basic Investing Strategies During Inflation

Inflation, characterized by the general rise in the prices of goods and services, can significantly impact your financial portfolio and purchasing power. When inflation is high, it is crucial to adopt investing strategies that help your investments outpace the inflation rate. Here are some key strategies and asset classes to consider during periods of inflation.

Understanding Inflation

Inflation occurs when there is too much money chasing too few goods and services, leading to a decrease in the purchasing power of money. Recent years have seen inflation rates rise to levels not seen in nearly 40 years, with the consumer price index (CPI) increasing by an average of 8% monthly in 2022, although it has eased somewhat in 2023 but remains above historical averages.

Diversification

Diversification is a fundamental strategy in any investment environment, and it is particularly important during inflationary periods. Spreading your investments across various asset classes can help mitigate the risks associated with inflation. This includes a mix of stocks, bonds, real estate, and commodities.

Stocks

Stocks, especially those in certain sectors, can be a reliable hedge against inflation. Historically, stocks have produced total returns that exceed inflation rates. Focus on equities in sectors such as consumer staples, energy, financials, and emerging markets, which tend to perform well during inflationary times. Additionally, industries experiencing post-pandemic rebounds, such as travel, leisure, and hospitality, can also offer growth opportunities.

Real Estate

Real estate is another tried-and-true inflationary hedge. Residential real estate, real estate investment trusts (REITs), and home construction materials are generally seen as safe havens. As inflation rises, property values and rental income tend to increase, helping to keep pace with inflation. For broad exposure to real estate, consider ETFs like the Vanguard Real Estate ETF (VNQ) or the VanEck Vectors Mortgage REIT Income ETF (MORT).

Commodities

Commodities, including raw materials and agricultural products, can be powerful inflation hedges. As the price of commodities rises, so does the price of the products that these commodities are used to produce. Investors can gain exposure to commodities through exchange-traded funds (ETFs) like the iShares S&P GSCI Commodity-Indexed Trust (GSG).

Treasury Inflation-Protected Securities (TIPS)

TIPS are U.S. Treasury bonds indexed to inflation, designed to protect investors from inflation. The principal value of TIPS adjusts based on the inflation rate, ensuring that the rate of return includes the adjusted principal. TIPS come in various maturities and can be accessed through ETFs such as the iShares TIPS Bond ETF (TIP).

Gold

Gold has historically been used as an alternative currency and a hedge against inflation. While it is volatile, especially in the short term, gold has seen an average annual gain of 9.48% over the 20 years between 2001 and 2021, outpacing the average inflation rate of 2.4% during the same period. Investing in gold-focused mutual funds or ETFs can reduce the costs associated with physical gold.

Leveraged Loans and High-Yield Bonds

Leveraged loans, often packaged into collateralized loan obligations (CLOs), and high-yield bonds can offer floating rate yields, which make them attractive during inflationary periods. These investments typically have higher risks but can provide returns that keep pace with inflation.

Dollar-Cost Averaging and Bond Laddering

Dollar-cost averaging involves making periodic investments with a fixed amount of money, which can help reduce market risk by averaging out the cost of investments over time. Bond laddering, which involves investing in bonds with staggered maturities, can also help manage inflation risk by providing a steady stream of income and reducing the impact of interest rate changes.

Conclusion

Investing during periods of high inflation requires a strategic approach to protect and grow your assets. By diversifying your portfolio with a mix of stocks, real estate, commodities, TIPS, and other inflation-resistant assets, you can better navigate the challenges posed by inflation. Remember to periodically review your portfolio to ensure it remains aligned with your financial goals and risk tolerance.