How to Hedge Against (or Profit From) Inflation

How to Hedge Against (or Profit From) Inflation

When prices are expected to increase more than usual, it's important to take a look at your investments and make sure they can hedge against inflation.

How to Hedge Against (or Profit From) Inflation
Real Estate

Real Estate

Farmland

Farmland

Commodities & Gold

Commodities & Gold

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 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's target inflation rate is just 2%. What's more, according to a survey done by The Wall Street Journal, economists expect high inflation to continue well into 2022. 

According to FactSet, the word "inflation" was mentioned on second-quarter earnings calls with investors more than ever before in the last decade. In other words, rising prices don't just affect your Target runs—they also have an impact on your investments. And depending on how you invest, inflation can either help or harm your portfolio.

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

Top investments to avoid when inflation is high

When inflation is high, 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, it's important to avoid making panicked or impulsive decisions with your investments. You shouldn't be pulling all of your money out of the stock market on a whim, but here are a few investments you might want to think twice about when inflation is high.

Growth stocks

Growth stocks, often tech 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 go up. 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 greater risk that inflation will make those returns less valuable than expected. On top of that, interest 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 keeping your money in place 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 high 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'll be missing out on higher interest rates because your money is stuck in a CD.

How to profit from inflation (or at least hedge against it)

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 (TIPS)

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, they have floating interest rates that can be adjusted up and down. During periods of high inflation, lenders can increase interest rates 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/REITs

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 looking to invest in real estate that can raise rents with inflation, so commercial REITs with long-term (think 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.

roofstock

Roofstock

4.0

Real Estate

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.

vaulted

Vaulted

Gold

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 commodities, making them one of the best assets for hedging against inflation. To invest in commodities, you can buy stock in companies that operate in the sector or invest in mutual funds or ETFs that focus 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. Fine art, for example, 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 these alternative assets anymore either. There are investment platforms now that let you buy shares in everything from a Picasso painting to Kanye West's $1.8 million Yeezys.

otis

Otis

4.3

Collectibles

Farmland

Similar to real estate, the value of farmland and rents on farmland often 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.

farmtogether

FarmTogether

5.0

Farmland

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 that are 10x higher than the Nasdaq 100. Many investors see it as a good hedge against inflation because it's limited in quantity. While the US government can print money to stimulate the economy (often causing inflation), there can never be more than 21 million Bitcoin.

coinbase

Coinbase

4.3

Crypto

It's Elastic

When inflation causes an increase in production costs, businesses can suffer. However, if companies are able to pass off these increased costs to consumers in the form of price hikes, it can actually lead to an increase in profit margins—as long as the price hikes don't kill consumer demand. As an investor, this means you generally want to look for goods with:

It's Elastic

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