Inflation-Proof Portfolio: Add These 5 Assets Today
Dear Rich Lifer,
It’s the biggest financial worry out there today: the threat of inflation.
For good reason. Inflation increased at the fastest rate in over 12 years as the U.S. economy roared back to life. The Consumer Price Index (CPI), which measures a basket of goods as well as energy and housing costs, rose 4.2% from a year earlier.
Meanwhile, the Federal Reserve says it will continue to keep interest rates low and make monthly bond purchases until inflation averages 2% over an extended period of time.
The Fed and many economists and policymakers are dismissing the current inflation as transitory. Michael Pearce, senior U.S. economist at Capital Economics, wrote, “As the cyclically-sensitive components of CPI are still rising at a modest pace, we doubt this report will change the view of officials that inflationary pressures are ‘largely transitory.‘”
Not everyone agrees that we can brush off the current inflation as a temporary financial setback. If there is an extended run of inflation, it could raise your cost of living, dip into your investment returns and increase the cost of borrowing.
Whether you are sick with worry over inflation or confident it’s a passing trend, read on to discover great ways to protect your portfolio from inflation so you can continue to lead a richer life.
Gold may be the most traditional hedge against inflation. However, like any, asset gold is not a perfect protector.
Russ Koesterich, co-manager of BlackRock Global Allocation fund, points out that in successive 12-month periods from December 1973 through May 2020, gold beat the CPI only 51% of the time.
Gold also pays no yield, unlike the other assets we have examined today. However, for long-term investors, it’s never a bad idea to allocate a small portion (3% to 5% max) of your portfolio to gold.
Commodities are a broader category of investment that includes grain, precious metals, oil, beef, foreign currencies, emissions, and even orange juice!
Inflation and commodities have a unique relationship because commodities are an indicator of inflation to come. As the price of a commodity rises, so does the price of the products that the commodity is used to produce.
You can invest in commodities via EFTs such as the S&P GSCI Commodity Total Return Index, which delivered positive inflation-adjusted returns in 83% of the high and rising inflation periods.
Many investors are confident in the long-term outlook of commodities and argue that prices have time to rise even further. Darwei Kung, head of commodities and portfolio manager at DWS Group, pointed out that the Bloomberg Commodity Index is still far below the peak it reached before the 2008-09 financial crisis.
Sean Markowicz, a strategist at Schroders, the U.K. asset-management firm, also noted that “Commodities are a source of input costs for companies and they’re also a key component of the inflation index, which by definition you’re trying to hedge.”
Do keep in mind, commodities can be volatile, and their value can easily move up or down depending on supply and demand.
Experts recommend you avoid tying up your money in long-term bonds, certificates of deposit, or growth stocks during times of inflation. Doug Bellfy, a certified financial planner at Synergy Financial Planning, advises his clients to “focus on short to intermediate-term bonds and avoid any investments that have ‘long term’ in the name.”
Alex Doll, a CFP and president of Anfield Wealth Management, also points out that “growth stocks tend to perform worse because they expect to earn the bulk of their cash flow in the future. And as inflation increases, those future cash flows are worth less.”
Instead, increase your allocations to value stocks or companies trading at below-average rates in the S&P 500 Index. Value stocks tend to fare better during inflation because these companies are usually in industries such as the financial and consumer staples sectors, which are usually not hit as hard by inflation.
There are two ways to invest in real estate in inflationary times. One is through real estate investment trusts (REITs), which are companies that own and operate income-producing real estate.
A REIT consists of a pool of real estate that pays out dividends to its investors. For a low expense ratio with broad exposure you could consider adding to your portfolio is the Vanguard Real Estate ETF (VNQ).
You can also invest in physical properties! Real estate works hand-in-hand with inflation because as inflation rises, so do property values. This means landlords can charge more for rent, earning higher rental income over time, which helps keep pace with rising inflation.
If you are close to retirement age and are worried about the eroding value of your savings, Treasury inflation-protected securities, or TIPS, are a great hedge against inflation.
Like traditional Treasury bonds, TIPS are issued and backed by the U.S. government. Investors collect regular interest payments based on the “par value” (face value) until the security matures, at which point you get back your principal.
TIPS are different because they come with inflation protection via a yearly adjusted par value that is determined based on the consumer price index. This changing, yearly value is designed to help TIPS maintain purchasing power. Typical Treasury bonds could lose value over time if inflation increases.
For example, right now, the 10-year Treasury bond is yielding about 1.6%, meaning it would lose purchasing power if inflation hits 2%.
Keep in mind, TIPS are best for short-term needs (around three years). If you are younger and retirement is still 10-15 years down the road, consider some of the other investments listed above for beating inflation…
As always, diversification is key, so an ideal portfolio would likely combine all of these asset classes to bring you the best protection from inflation.
To a Richer Life,
The Rich Life Roadmap Team