How to Hedge Against (or Profit From) Inflation

Inflation is heating up, and the economic stove is set to stay on high for a while—which has investors worried about getting burned.

Prices rose on just about everything in September, with food (up 0.9%), energy (up 1.3%), and new vehicles (up 1.3%) seeing some of the steepest increases, according to a recent Consumer Price Index (CPI) inflation report. Across all goods and services, prices are now up 5.4% year over year. For context, the Federal Reserve target inflation rate is just 2%.

The key is knowing how to hedge against inflation—or even how to make money from inflation—with how you invest. Here's what you need to know about how to profit from inflation, including the worst and best investments when inflation is high.

When inflation goes up, your money doesn't go as far. If your investments are underperforming on top of that, it's a double whammy of financial setbacks, which can be particularly rough if you're nearing retirement. That said, avoiding panicked or impulsive decisions with investments is crucial.

You shouldn't be pulling all of your money out of the stock market on a whim, but here are a few assets you might want to avoid investing in if you're looking for how to profit from inflation.

Growth stocks

Unlike fixed income stocks, growth stocks tend not to perform as well during periods of inflation. These are companies that often have little to no cash flow in the present but expect that cash flow to grow significantly—in other words, their value is tied to future earnings.

When costs are expected to increase, especially given that's usually paired with rising interest rates, it's hard to be optimistic about future cash flow. This is why you'll often see big sell-offs of tech stocks when inflation is set to increase. However, other factors are always at play, and plenty of experts expect the big tech stocks to continue growing despite inflation.

Long-term bonds

When it comes to long-term bonds, inflation stands to erode the value of future payments. If a bond isn't set to pay out for 10 years or more, there's a greater risk that inflation will make those returns less valuable than expected. On top of that, Fed rates tend to go up when inflation rises, which causes bond prices to fall—and long-term bonds are typically more sensitive to interest rates.

Certificates of deposit (CDs)

Certificates of deposit (CDs) are more of a savings product than an investment as they offer low fixed interest rates for depositing your money for anywhere from a few months to a few years. Due to their lower rates, you're lucky to outpace inflation with a CD during normal times, let alone periods of inflation. This is particularly true when interest rates are low, as you're locking in lower returns.

As inflation heats, interest rates are likely to rise, but you're likely missing out on higher rates because your money is stuck in a CD. Money in a savings account is usually more effective than a CD when the Federal Reserve hikes rates.

As prices go up, you can protect your purchasing power by investing in assets that hedge against inflation. These are assets that typically maintain their value or increase in value, even when inflation is high.

Treasury inflation-protected securities

Treasury inflation-protected securities (TIPS) are bonds issued by the Treasury that are indexed to inflation. This means they inherently provide protection against inflation, making them a good option when the economy is heating up.

However, if inflation doesn't end up rising or if it falls, TIPS prices can go down. In addition to being able to buy TIPS directly from the Treasury, you can also invest in mutual funds or exchange-traded funds (ETFs) that invest in TIPS.

Leveraged loans

Leveraged loans tend to have higher interest rates, and on top of that, have floating interest rates that can be adjusted up and down based on the economy and federal reserve policy.

Lenders can increase interest rates during periods of high inflation to maintain returns. This is why leveraged loans can help investors profit from inflation. Various investment funds, including some mutual funds and ETFs, invest in leveraged loans.

Real estate

Real estate tends to be a good investment for hedging against inflation. When inflation goes up, so does rent—and it's better to be on the side that's collecting rent rather than paying it. Real estate investment trusts (REITs) make it easy to invest in real estate the same way you'd invest in stocks, and historically, they've almost always managed to outpace inflation. This does depend on the type of REIT.

You're probably looking to invest in rental properties that can charge more with inflation, so commercial REITs with long-term (10- or 15-year) leases probably won't be the best option. Residential REITs and hotel REITs, for example, can increase rents to make up for inflation.

Gold

Gold has historically been a popular hedge against inflation. Putting your money in gold can protect your purchasing power, especially in the long run. One study found that gold ranked third (with TIPS and REITs coming in at first and second) as a hedge against inflation in rising environments. Just keep in mind there are no guarantees. Historically, there have been periods of inflation during which gold actually produced negative returns.

Commodities

Commodities—or raw materials such as food, grains, coffee, livestock, lumber, cotton, and precious metals—tend to go up in price along with inflation. Recent research from Vanguard actually shows that a 1% increase in inflation should produce a 7% to 9% rise in commodity prices, making them one of the best assets for hedging against inflation.

To invest in commodities, you can buy stock in companies operating in the sector or invest in mutual funds or ETFs focusing on the sector.

Collectibles and art

Real assets such as fine art, wine, and collectibles tend to be a good store of value during times of high inflation. For example, fine art is less volatile than many other assets and often increases in value as prices go up. The same is true of investment-grade wine and collectibles like rare sports cards and sneakers.

You don't need to drop a few million on a painting or buy a $10,000 bottle of wine to invest in alternative assets, but they're also not something you gain exposure to through money market accounts. Investment platforms like Masterworks now let you buy shares in everything from a Picasso painting to Kanye West's $1.8 million Yeezys.

Farmland

Similar to real estate, farmland value and rental income tend to rise with inflation. In addition to being correlated with inflation, farmland is one of those rare assets that historically produces returns comparable to the stock market while being significantly less volatile. If you're agriculturally savvy, you could go out and buy up some Iowa farmland, or you can use a platform like FarmTogether to invest in farms that are already operating and generating revenue.

Cryptocurrency

Cryptocurrency is notoriously volatile, as its value isn't tied to anything real, so predictions about how it will perform in the face of rising inflation are speculative. That said, Bitcoin is the best-performing asset of the decade—it's produced returns 10x higher than the Nasdaq 100.

Many investors see it as a good hedge against inflation because of its limited quantity. While the US government can print money to stimulate the economy (often causing inflation), there can never be more than 21 million Bitcoin. While BTC prices are a rollercoaster ride, the best stablecoins let you exit your crypto position without ever leaving the blockchain.

Where you store your crypto can also make or break your investment. It's usually a choice between a non-custodial crypto wallet or an exchange, but going for hardware wallets like Ledger or Trezor can also be tough. Whatever you decide, always have an emergency button that sells your crypto for fiat or solid stablecoins.