Pull the cash out of your wallet and compare one $1 bill to another. They look the same, right? A dollar is a dollar, after all. But even though they won’t look any different, a dollar today may not be worth the same as a dollar tomorrow.
That’s because of inflation. In simple terms, inflation is the increase in prices for goods and services over time, which results in a decrease of a dollar’s purchasing power. It’s a natural economic occurrence that can happen at varying speeds. If you’re concerned about inflation’s impact on the cost of household goods, you aren’t alone — but you can use your investment portfolio to lessen the effects.
1. Invest with TIPS.
One way to manage inflation’s effect on your portfolio is to choose investments designed to be a built-in hedge against it. Treasury Inflation Protected Securities, or TIPS, are a type of treasury bond specifically designed to help investors ride out waves of rising and falling inflation over time.
When investing in TIPS, the principal is tied to changes in the Consumer Price Index (CPI), which measures inflation. TIPS’ principal increases with inflation (rises in the CPI) and decreases with deflation (declines in the CPI). TIPS pay interest at a fixed rate twice per year based on the adjusted value of the principal.
TIPS are some of the safest ways to invest against inflation because they’re government-backed bonds. So no matter how inflation moves, the risk of losing money is less than other investments.
2. Add real estate to the mix.
Real estate is considered a hedge against inflation — and can even be a potential earning opportunity when prices are rising. That’s because if the price of real estate goes up too, there’s potential for greater resale value down the line.
Different ways to invest in real estate can yield various benefits. First, there’s direct ownership in which you own property and rent it out to tenants. When inflation drives consumer prices higher but demand for rental housing remains steady, landlords can leverage that to increase rental prices. Your profit margin assumes, of course, that the cost of maintaining the property doesn’t outpace the rate at which you’re increasing rents.
Another option is indirect ownership through a real estate investment trust (REIT) or a real estate fund. REITs are legal entities that own and invest in real estate, while real estate funds are mutual funds that may contain REITs, REIT indexes or funds, and possibly stocks of companies in the real estate industry.
3. Diversify with the right stocks.
Using stocks as a hedge against inflation can be an effective strategy if you choose the right companies to invest in and the move fits with your investment objectives.
For instance, it would make sense to invest in companies that are able to raise their prices along with the rate of inflation (like ones in the consumer staples sector). This can help them potentially maintain a stream of profits, which can benefit your portfolio if the company pays out dividends to shareholders.
Also, consider how inflation fits into the larger economic cycle picture. If rising prices are pushing you to spend less on nonessentials, for instance, choosing defensive stocks could be a good play. Defensive stocks are ones that represent things consumers always spend money on, like food, energy and household products.
During the early stages of a recession, for example, defensive stocks can get a boost as people may focus their spending on necessities. As a recession eases, and inflation along with it, some investors may reallocate to cyclical stocks (those that represent companies with discretionary goods and services, like hotels and restaurants) that tend to outperform in strong economies.
Other investors may also consider looking beyond domestic stocks to international and emerging markets. When inflation is confined to one economic ecosystem, i.e. the United States, investing globally in companies that are doing well could help balance out lagging returns.
4. Consider precious metals.
Precious metals, such as gold, have long been used as a valuable inflationary hedge.
As an asset class, gold tends to hold its value (or even gain value) better than other investments during periods of higher inflation. To invest in gold, you don’t need to buy gold bricks or jewelry. An easy way to access gold investments or other precious metal investments is through an exchange-traded fund or ETF.
Gold ETFs can offer the benefits of gold investing in a highly liquid package, since ETFs trade on an exchange just like a stock. You can invest in gold ETFs through an online brokerage, like Ally Invest.
Take the next investing steps for potential inflation protection.
If you haven’t invested before but are interested in it, now may be a good time to consider a Self-Directed Trading account. When you opt for self-directed trading, you’re in charge of deciding what to invest in.
While the idea of money losing its purchasing power can sound scary, it’s important to remember that inflation is normal — even though the rate at which it occurs fluctuates. By building your portfolio around assets that offer some insulation against the impacts of rising prices, you can help keep the effects of inflation on your wallet at bay.
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