Q: The rising prices on everything, from fuel to food products, makes me fear for the security of my portfolio. How can I insulate my investments against inflation?
A: There’s not much you can do about the rising cost of goods, but as an investor, there are steps you can take to protect your portfolio. Here are five ways to insulate yourself against inflation.
1. Invest in Gold
Gold has always been considered a hedge against inflation. When currencies across the world are losing value or fluctuating in value, gold is a constant — a real, physical asset that will always have value.
It’s important to note, though, that gold is not a perfect hedge against inflation. When the inflation rate increases, the national interest rate tends to follow suit. Investing in gold instead of an asset that can yield interest can mean missing out on higher dividends during a time of inflation. Your best course of action in times of inflation is likely to diversify your portfolio with some shares in gold rather than going all in on it.
2. Reconsider the Bonds in Your Portfolio
Asset prices often rise in inflationary environments. Unfortunately, though, when interest rates rise, the value of bonds can decrease. This means that bonds in your portfolio can be a dead weight when rates are going up. Under these circumstances, it can be wise to consider a nonconventional approach toward balancing your portfolio and decreasing bond allocation for better returns.
You may also want to think about buying more aggressive types of bonds now, such as high-yield bonds and emerging market bonds. These will offer more protection against future inflation since they provide higher incomes. They do come with a higher credit risk, though, so proceed with caution.
3. Consider TIPS
Another step to consider taking with bonds now is to focus on Treasury Inflation Protected Securities, or TIPS. TIPS are government-backed bonds issued by the United States Treasury with an inflation protection component. As government-issued securities, there’s no risk of these bonds defaulting. In addition, TIPS have an inflation rider that automatically adjusts the value of your principal along with the Consumer Price Index. Keep in mind, though, that if interest rates rise, the value of TIPS will fall like any other bond. However, they can still be a valuable addition to your portfolio during an inflationary environment.
4. Include Stocks in Your Portfolio
If you don’t already do so, be sure to have some stocks in your portfolio during a time of rising inflation. Stocks can offer a hedge against inflation in two ways:
- Stocks Pay Dividends. Dividends increase along with the company’s profits. In contrast, bonds pay a fixed amount, which means they are essentially paying less when the value of the dollar falls.
- Stocks Provide Growth. Over time, the market tends to grow. Consequently, a broadly diversified portfolio generally moves higher over a prolonged period of time. Growth offers a cushion against inflation by providing you with the funds you need to maintain your standard of living even when the inflation rate increases.
5. Real Estate
The real estate market has experienced an explosion since the coronavirus pandemic and can be a great hedge against inflation for the savvy investor. Of course, you will need to have a large amount of cash and the resources for managing a property in order to invest in real estate. However, if you can swing it, adding real estate to your portfolio can help increase your cash flow when the cost of living rises due to inflation.
If you’re hesitant to invest in a physical property now, consider owning publicly traded securities instead, or a real estate investment trust (REIT). Modeled after mutual funds, an REIT is a company that owns, operates or finances income-generating real estate for investors.
The rising inflation rate can make investors fear for the security of their portfolio, but there are proactive steps investors can take to insulate their investments against inflation. Follow the tips outlined here to help keep your portfolio safe during a rising inflationary environment.
Your Turn: What steps are you taking to insulate yourself against inflation?