Hedging Against Inflation in Your Portfolio
Hedging Against Inflation in Your Portfolio
Rising inflation is a concern among investors. Here are five ways to help protect your investments.
Over the past year, investors have become increasingly worried about how inflation might impact their portfolios. One measure of inflation, the Consumer Price Index (CPI), climbed to 7.5 percent in January, its highest level in four decades. Supply chain issues, government stimulus, and increased consumer demand have contributed to higher prices for goods and services.
Inflation can be a problem for investors because it decreases the spending power of every dollar saved—over the long-term, your money won’t stretch as far. Luckily, there are steps you can consider to hedge against inflation and help protect your portfolio. Here are five strategies to consider.
- Stay invested in stocks
Inflation is a normal part of the market, but during times of high inflation, it’s worth revisiting your portfolio to determine if it still meets your desired rate of return and risk tolerance. Stocks offer higher potential returns, which can help you outpace the rate of inflation. But they can also be volatile. Consider holding a greater portion of stocks to take advantage of higher returns if your risk tolerance allows it.
- Minimize exposure to traditional bonds
The Federal Reserve will likely raise interest rates this year in an effort to control inflation. Traditional bond prices are inversely related to interest rates. In other words, when interest rates rise, bond prices usually decrease. As a result, during times of high inflation, you may want to avoid overexposure to bonds in your portfolio, as they can rapidly decrease in value when interest rates rise.
- Consider TIPS
Treasury inflation-protection securities (TIPS) are a type of U.S. Treasury bond designed to keep pace with inflation. TIPS are backed by the U.S. government and considered some of the safest investments available. When you buy TIPS, you are lending money to the government and receiving interest in return in the form of a coupon payment. The principal value of TIPS is indexed to the rate of inflation. When inflation rises, the principal value does too, which in turn increases your coupon payment. When inflation falls, the principal value decreases, and coupon payments decrease as well. You can buy TIPS with maturities of five years, 10 years, and 30 years.
- Invest in real estate
Real estate typically does well during inflationary periods largely because as inflation rises, landlords are able to pass higher costs on to their tenants. You can invest in real estate directly by becoming a landlord and collecting rent on properties you own. Or you can invest indirectly by buying shares in real estate investment trusts, or REITs. REITs are companies that own and manage real estate, such as office buildings, apartments, or retail spaces. The companies generate income by collecting rent. They then pass the profits on to their shareholders. By law, REITs must pass 90% of their profits to their shareholders.
- Explore commodities
The price of commodities, such as oil and corn, tends to rise with inflation, making commodities a popular inflation hedge. You can invest in commodities through mutual funds or exchange-traded funds that hold diversified baskets of investments. Another way to take advantage of the positive correlation between commodities and inflation is to invest in businesses heavily involved in commodities, such as mining companies, for example.
Remember that your investment portfolio is constructed based on your long-term goals, risk tolerance, and time horizon. Avoid making rash investment decisions based on potential short-term changes in the economy. Be sure any hedging strategies you use fit your overall plan and help you stay on track to meet your financial objectives.
Sources
https://www.investor.gov/introduction-investing/investing-basics/glossary/treasury-securities
https://www.treasurydirect.gov/instit/marketables/tips/tips.htm
https://www.treasury.gov/resource-center/fin-mkts/Pages/tips.aspx
Material prepared by Oechsli a third party non-affiliated with Raymond James.
Any opinions are those of Steven Bayardelle or The Wang Group and not necessarily those of RJA or Raymond
James. The information contained in this report does not purport to be a complete description of the securities,
markets, or developments referred to in this material. The information has been obtained from sources considered to
be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. Any
information is not a complete summary or statement of all available data necessary for making an investment decision
and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of
strategy selected. You should discuss any tax or legal matters with the appropriate professional.
Holding stocks for the long-term does not insure a profitable outcome. Investing in stocks always involves risk,
including the possibility of losing one's entire investment.
Bond prices and yields are subject to change based upon market conditions and availability. If bonds are sold prior to maturity, you may receive more or less than your initial investment. There is an inverse relationship between interest rate movements and fixed income prices. Generally, when interest rates rise, fixed income prices fall and when interest rates fall, fixed income prices rise.
Be advised that investments in real estate and in REITs have various risks, including possible lack of liquidity and devaluation based on adverse economic and regulatory changes. Additionally, investments in REIT's will fluctuate with the value of the underlying properties, and the price at redemption may be more or less than the original price paid.
Treasury Inflation-Protected Securities (TIPS) provide protection against inflation by adjusting their principal amount annually based on the Consumer Price Index (CPI) and then paying interest on that new amount. The principal amount is readjusted every year based on the prior year's CPI, meaning it can go down as well as up. When TIPS mature, the investor receives either the current principal value or the original amount invested in the TIPS bond, whichever is higher. TIPS offer the benefit of diversification as well as being a hedge against inflation. Their principal value is guaranteed by the U.S. government and they are highly liquid - they can be bought or sold before they mature. If sold prior to maturity an investor will receive the current market value, which may be more or less than the amount invested. TIPS will lose value in deflationary periods. They should be held only in nontaxable accounts such as an IRA because increases in the principal amount are considered taxable income in the year they occur even though the principal amount is not actually returned to the holder until maturity. Real estate investments can be subject to different and greater risks than more diversified investments. Declines in the value of real estate, economic conditions, property taxes, tax laws and interest rates all present potential risks to real estate investments. Investing in commodities is generally considered speculative because of the significant potential for investment loss. Their markets are likely to be volatile and there may be sharp price fluctuations even during periods when prices overall are rising. Links are being provided for informational purposes only. Raymond James is not affiliated with and does not endorse, authorize or sponsor any of the listed websites or their respective sponsors. Raymond James is not responsible for the content of any website or the collection or use of information regarding any website's users and/or members.
