Today’s dollar will not purchase the same goods value in ten years. This is because inflation. Inflation is the average price of a basket goods and services in an economy. It refers to increases in prices over a specific period. Inflation means that a certain amount of currency can be bought less than it used to. It is therefore important to identify the best strategies and investments to protect against inflation.
According to current events, the level of inflation in an economy varies. Inflation can be caused by rising wages or rapid increases in raw material, such as oil.
Inflation is a normal occurrence in the market economic system. There are many ways to protect against inflation. A disciplined investor can plan ahead for Finance by investing only in assets that outperform during high-inflationary conditions.
Your portfolio can thrive when inflation strikes by keeping inflation-hedged asset types on your watchlist and then striking when you notice inflation taking shape in an actual, organic growth economy.
Gold is often considered an hedge from inflation. Many people consider gold an “alternative currency,” especially in countries where their native currency is declining in value. These countries often use gold and other strong currencies to replace their currency when it is losing value. The most valuable asset in the world is gold.
A rise in the cost of goods and services is what causes inflation. Supply and demand drive an increase in the cost of goods and services. Prices can rise due to increased demand, but prices can be driven down by a decrease in supply. Consumers have more money and demand can rise.
But gold is not an ideal hedge against inflation. However, gold is not a perfect hedge against inflation.
When you want to insure yourself against inflation, there are better assets than others. There are better assets to invest in if you want to protect yourself against inflation. 2
Commodities is a broad category that includes commodities such as grain, precious metals and electricity. It also includes oil, natural gas, food, and other financial instruments. Inflation and commodities have a unique relation. Commodities are an indicator for future inflation. The price of the commodities that are used to produce them rises with the commodity’s price.
It’s possible to invest broadly in commodities using ETFs (ETFs). The iShares S&P GSCI Commodity Indexed Trust ( GSG ) is a good commodity ETF to consider.
Investors should be aware of the volatility of commodities and caution when trading them. Commodities are highly dependent on supply and demand factors. A slight shift in supply can negatively impact the price of commodities.
- A 60/40 Stock/Bond Portfolio
A 60/40 stock/bond portfolio can be considered a traditional, safe mix of stocks and bonds that is conservative. If you are unable to do the work yourself and don’t mind paying an investment advisor, Dimensional DFA Global Allocation Portfolio 60/40 (I) is a safe, traditional mix of stocks and bonds in a conservative portfolio.
An easy and straightforward investment strategy is the 60/40 stock/bond portfolio. It does come with some drawbacks, as do all investment strategies. A 60/40 portfolio will outperform an all-equity portfolio over the long-term, but it is less likely to underperform. A 60/40 portfolio could also be significantly less successful over long periods of time due to compounding interest.
A portfolio that is 60/40 will protect you from inflation and keep you safe, but it will likely not provide the same returns as a portfolio that has a higher proportion of stocks.
- Real Estate Investment Trusts (REITs)
REITs are real estate investment trusts that have the ability to own and manage income-producing real property. Inflation causes property prices to rise and rental income to increase. An REIT is a fund that holds real estate and pays dividends to its investors. The Vanguard Real Estate ETF ( VRQ) offers broad exposure to real-estate, with low expenses.
There are also some disadvantages to REITs such as their insensitivity to high-yield assets and demand. Treasury securities are more attractive when interest rates rise. This can reduce the share price of REITs by drawing funds away.
REITs also have to pay property taxes. This can amount up to 25% of total operating costs. The possibility that state or municipal authorities increase property taxes in order to cover budget deficits would result in a significant reduction of cash flow to shareholders. Finally, even though REITs can offer high yields and are subject to taxes, the dividends are still subject to tax. Finally, even though REITs offer high yields, taxes are due on the dividends. 6
- The S&P 500
Stocks have the longest-lasting upside potential. Businesses that don’t require much capital are the ones that benefit from inflation. Businesses that engage in natural resources, however, are considered inflation losers.
The S&P 500 currently has a high concentration in technology businesses and communications services. They hold a 35% share in the Index. Technology and communication services both are capital-light businesses so they should theoretically be inflation winners.
You can invest in the S&P500, which is an index of 500 U.S. public companies. Or, if you prefer an ETF that tracks this index for your watch list, the SPDR S&P500 ETF ( SPY)
There are, however, some drawbacks to investing in S&P 500 Index. The Index gives greater weights to companies that have higher market capitalizations. This means that stock prices for larger companies have a greater impact on the Index than stocks of smaller companies. The S&P 500 index doesn’t provide exposure to small-cap stocks, which historically have produced higher returns.
- Real Estate Income
Renting out a property is an example of real estate income. Inflation is not a problem with real estate. Because inflation increases, so do property prices and the rent a landlord can charge. The landlord will see a rise in rental income as a result. This allows the landlord to keep up with inflation. Real estate income is a great way to protect your investment portfolio from inflation.
Real estate investing is like any other investment. There are pros and cons. First, real estate transactions are more expensive than buying shares of stock. Real estate investments are not liquid, so they cannot be sold quickly or easily without significant loss of value. You will need to manage and maintain the property if you purchase it. These costs can quickly add up. Real estate investing can also be a risky venture that could lead to financial and legal liabilities.
- Bloomberg Aggregate Bond Indicator
The Bloomberg Aggregate Index Bond Index measures the U.S. market for bonds. The index covers all bonds: municipal, corporate, and government bonds. Funds that seek to replicate the index’s performance can be used by investors to invest in the index. This index is tracked by many funds, including the iShares Core U.S. Aggregate Bond ETF (AGG).10
There are disadvantages to investing with the Bloomberg U.S. The Aggregate Bond Index is a core fixed income allocation.
It is first weighted towards the agencies and companies with the highest debt. Unlike the S&P 500 Index, which is market-capitalization-weighted–the bigger the company, the bigger its position in the index–the largest components of the Bloomberg U.S. The Aggregate Bond Index is a list of agencies and companies with the highest amount of outstanding debt. It is also heavily weighted towards U.S. government exposure so it is not always well-diversified across bond markets.
- Leveraged loans
A leveraged loans are loans that are made to companies with high debt levels or low credit scores. These loans are more risky and can lead to default, so they are more costly for the borrower.
Leveraged loans are often referred to collateralized Loan Obligations as an asset class. These are multiple loans that have been combined into one security. Investors receive scheduled debt payments from the underlying loan. CLOs have a floating yield which makes them an excellent hedge against inflation. Invesco Senior Loan ETF ( BKLN) is an option if you are interested in this strategy. 11
Leveraged loans are like any investment. There is a tradeoff between the rewards and the risks. There are some risks associated with investing in funds that invest into leveraged loans. These include liquidity and credit default.
Leveraged loan borrowers can close down their business or become insolvent. The leveraged loans are not as easy to purchase or sell as securities that are publicly traded. Finally, leveraged loans have less protections for the lender than traditional loans. If the borrower defaults on the loan, this could expose the fund to higher losses.
Treasury inflation protected securities (TIPS) are a type U.S. Treasury bond that is indexed to inflation to protect investors against inflation. TIPS is paid at a fixed rate twice a year. TIPS’ principal value changes according to inflation. Therefore, the rate of return also includes the adjusted principal. TIPS are available in three maturities: 5-year, 10-year and 30-year.