Any serious investor could see rising inflation rates and become panicked. Even if investors continue to receive growth and positive returns, inflation can potentially erode their portfolios’ purchasing power.
The average rate of inflation over the past 60 years has been 3.7%, meaning that investments must return an average of this amount yearly – just to maintain purchasing power. If investors require growth, and presumably all of them do, then higher rates of return are needed. In an average year, for example, if inflation is 3.7%, then an investment paying 10% interest will offer a ‘real’ return of just 6.3%.
This means that the ultra-low interest rates that have been offered on basic savings accounts in recent years actually result in a loss of purchasing power, even in an ‘average’ year, meaning that investors lose money, in real terms, year over year.
“Inflation is the silent wealth killer…” Chris Berkel, investment advisor and founder of AXIS financial.
During the last year or two, inflation in the US has risen to levels not seen since the 1980s. It is no wonder that investors are searching for advice regarding effective inflation hedges that will at least maintain their wealth, and hopefully continue to increase it.
Financial analysts and investment advisors may differ on the relative importance of various investment types that can provide protection against the effects of inflation; however, there does seem to be a consensus about several main options that investors should consider: TIPS, stocks, and commodities, along with alternative investments such as commercial real estate, private equity, cryptocurrencies, and gold.
Treasury Inflation-Protected Securities (TIPS)
The name says it all. For investors in the US, TIPS are a solid option that are as “safe as houses.” Certainly, TIPS offer a guarantee that the purchasing power of one’s wealth will not decrease; they are issued by the US Treasury and are guaranteed to keep up with inflation. Investing in TIPS will certainly maintain your wealth; the downside is that such an investment will not necessarily provide growth. The purchasing power of your wealth is guaranteed not to decrease, yes, but it may not necessarily increase either. TIPS are an extremely safe choice, but many seasoned investors will be looking for something more.
| Pros | Cons |
| Maintain value compared to inflation Minimal risk | Value guaranteed, but may not increase Generally, require 5+ year term |
Stocks
In times of rising inflation, Investopedia recommends shifting 10% of one’s portfolio from bonds to equities, and suggests utility stocks, in particular. Stocks can provide good protection against inflation in the long term. Using the S & P 500 as a benchmark, stocks have seen average returns of 9.5% (assuming that dividends are reinvested.)
However, from November 2020 to November 2021, the S & P rose by 32% while inflation increased at slightly less than 5%, a highly desirable situation for those investors holding stocks.
Even still, stocks should likely be considered as part of a diverse portfolio of medium- to long-term investments; they may not perform so well in the short term, especially if the inflation rate drops.
A period of unusual inflation, which may be temporary, is often not the best time to make a large increase in the proportion of stocks in one’s portfolio.
| Pros | Cons |
| Offer good long-term protection against inflation Relatively low cost and high liquidity | Subject to market volatility Riskier as a short-term investment, especially if there is deflation |
Private Equity
Private equity funds provide returns on investment (ROI) that generally exceed those available in the public equity markets, making them attractive as an inflation hedge in the medium to long term. Private equity funds are not publicly traded and are only available to high-net-worth investors, appealingly mostly to institutional investors. For those clients, however, the benefits of private equity can be considerable.
| Pros | Cons |
| High ROI offers good inflation hedge | Only accessible to high-net-worth individuals and institutional investors |
Commodities
A broad term that covers any item that has intrinsic value. Commodities include agricultural and other food products, minerals, energy-related products, and precious metals.
However, like stocks, investing in commodities is not without risk; the price of any commodity may rise and fall, depending on natural disasters, politics, or other unforeseeable events – such as wars and pandemics.
They are subject to the laws of supply and demand. You can see this clearly with the Russian invasion of Ukraine, where supplies of grain and oil have been seriously impacted.
| Pros | Cons |
| Have intrinsic value Demand should be reliable | Subject to law of supply and demand Not risk free |
Real Estate
Whether referring to one’s own home, or to commercial real estate (both residential and industrial), real estate has proven over time to be one of the most effective inflation-proof investments out there.
As an asset class, real estate has little correlation with stocks and bonds, often moving in the opposite direction. However, real estate values increase reliably over time, often outstripping other investments. As a long-term investment, home ownership cannot be beaten.
Yet, many people will not regard their own home in the same light as other investments. This is because it is the place where they live and not something they aim to sell.
Similar to home ownership, commercial real estate appreciates reliably over time and will provide a steady income before you sell the property. Retail property, apartment buildings, and industrial buildings are all excellent inflation-proof investments in the long term.
However, repairs and maintenance, plus dealing with tenants, and occasional vacancies, can all add up to major headaches for investors. Further, investing in commercial real estate also requires sizable down payments, putting it out of reach for many individual investors.
Apart from the requirement to have large amounts of cash upfront, the other downside is the illiquidity of real estate.Sales generally take time and effort, even in the current red-hot market, and the cost, relative to other investment vehicles, is huge.
Realtor commissions and legal fees can take a huge bite out of one’s profits, and are payable on the entire property value, regardless of the amount of the investor’s equity in the property.
| Pros | Cons |
| Value appreciates reliably over time – good inflation hedge Provides a regular, inflation-linked rental income | Illiquidity Can involve ongoing costs and hassles with tenants, leases, and maintenance |
Real Estate Investment Trusts (REITs)
REITs are one way you can benefit from the inflation-proof returns enjoyed from investing in commercial and residential real estate without the high upfront costs, headaches of ownership, and illiquidity of owning a particular building, or buildings.
REITs are companies or mutual funds that own commercial and residential properties, paying their investors with income from rental properties; they enjoy high liquidity, being easily traded.
REITs provide individual investors with easier and more affordable access to the lucrative real estate market, without any of the headaches that come with purchasing property. However, dividends are subject to higher taxes, as significant proportions are taxed as income.
| Pros | Cons |
| Allow individual investors to benefit from the real estate market without huge upfront costs Can be easily traded | Higher taxes on dividends |
Cryptocurrencies
Certainly, some investors have earned impressive returns from cryptocurrencies. However, cryptocurrencies have been around for little more than a decade, so there is limited history to support them as an inflation hedge. They have also shown unpredictable levels of volatility; for example, bitcoin lost 25% of its value in three days in January, despite there being no easing of inflation during that time.
| Pros | Cons |
| Can provide impressive gains | High volatility Short history – making them difficult to evaluate |
Gold
Gold is frequently touted as the perfect inflation hedge. Arguably, gold bars maintain their value where fiat currencies lose purchasing power in times of inflation. However, apart from the ‘hidden’ costs of security, storage and insurance, the price of gold does not always rise or fall in tandem with inflation but is affected by other factors, including political uncertainty and world events. Gold will generally protect wealth in the long term but – as an inflation hedge – this may be true only in the extremely long term – decades, if not centuries.
| Pros | Cons |
| Good inflation hedge – in the long term Maintains value compared with fiat currencies | Storage, insurance costs Inflation proofing is only valid over the VERY long term |
Summary:
The ideal inflation hedge is an investment that is pretty much guaranteed to experience growth comfortably ahead of the rate of inflation, preferably with: minimal volatility, low risk, reasonable management costs, high liquidity, and affordable access for individual investors – quite a shopping list!
Investing during inflationary periods is complex; there are no easy solutions and different investment vehicles will suit different investors at different times, depending on their personal circumstances, their short- and long-term needs, their risk tolerance, and their ultimate goals.
To learn more about investment strategies during inflationary periods, you should contact professionals with years of experience in the financial industry. At Titan Funding, our team has helped many people in Florida and across the nation take advantage of private investing and earn sizeable returns on investment. Contact us today to learn more about our private investment opportunities.