With trillions of dollars (and counting) announced in the COVID-19 stimulus, economists and pundits alike have started pondering the possibility of rampant inflation.
Not immediately, of course. Right now, American consumers have tightened their spending considerably in the face of mass unemployment. But trillions of new dollars in the economy can’t stay buried forever. At some point, they’ll start circulating with a vengeance.
And when that happens, the price of goods and services could spike, and the value of each dollar could collapse. In turn, that devalues our retirement savings and investments.
But not all investments get hit evenly by dollar decay of inflation. Some weather inflation better than others and simply adjust pricing alongside inflation.
So which investments ride the wave of inflation rather than breaking underneath it? As you move to protect your portfolio from inflation, keep the fundamentals in mind.
First, not all inflation is bad. The Federal Reserve aims for 2% annual inflation for a slow, stable upward climb. Healthy economies produce growing incomes, and with more money to spend, consumers drive up the prices of goods and services with gradually increasing demand.
Plus, inflation reduces the real value of the national debt.
But fast inflation diminishes the value of our currency — and therefore our savings and investments — too quickly. For a quick example, imagine you’re a bank lending money for mortgages at 3.5% interest, but money starts losing value at 5% annual inflation. Suddenly, you’re effectively losing 1.5% on your loans every year. Expect a hard time staying in business. And when banks start going under, borrowers and businesses can’t get loans and the economy grinds to a halt.
Multiple economic forces can cause inflation. The Fed “printing money” is a common one, though that’s a misnomer, as they don’t physically print bills. They simply make loans and buy Treasury bonds with digital money that didn’t exist before they created it out of ones and zeroes.
Tax hikes also cause inflation. When governments raise taxes on businesses, businesses don’t just roll over and accept low profits or losses. They raise their prices, so the same goods and services suddenly cost more.
The same effect happens when raw goods or supplies go up in price. For example, if a blight knocks out half of the nation’s wheat supply, the price of wheat would go through the roof. And every producer who relies on wheat, from bakers to brewers and beyond, would raise prices to compensate.
Protection Through “Real” Assets
Some things have inherent value. No matter how weak or strong the currency you use to pay, the underlying value remains relatively consistent.
Food, for instance, has inherent value. If a loaf of bread costs a dollar today and inflation spikes 30%, the cost adjusts accordingly to $1.30 because people are still just as willing to pay for it, regardless of the currency value.
The same goes for other physical assets with inherent value, like real estate and precious metals. A few paper assets also protect against inflation, although they do so through more artificial means, such as the Treasury adjusting the value of Treasury inflation-protected securities.
As you explore inflation-resistant investments, keep in mind that no investment is entirely inflation-proof. These investments do well historically against inflation, but that doesn’t mean they leave you entirely immune.
1. Real Estate
People need a roof over their heads and will pay the going rate for housing, whatever that is in today’s currency.
The value of the dollar in the United States roughly halved in the 30 years from 1990 to 2020, per the Bureau of Labor and Statistics. The median home price in 1990 was $117,000, according to the Fed. Yet in the first quarter of 2020, the median home price was $324,500.
Note that home prices outpaced inflation significantly. Home prices are nearly triple their 1990 values, even though the U.S. dollar is only worth half what it was back then.
So how can investors take advantage of real estate’s inflation-resistant power?
Buy a Rental Property
And one of those often ignored perks is inherent protection against inflation. As a rental property owner, you raise the rent each year to keep pace with market pricing — which usually exceeds inflation.
Consider that the median U.S. rent in 1990 was $447, per the Census Bureau. By 2020, the median U.S. rent climbed to $1,197 for a two-bedroom apartment, according to Apartment List, and the Zillow rent index sat at $1,594. (Census Bureau data lags by several years.)
No matter how you slice it, rent has risen faster than inflation. Remember, the value of the dollar was roughly half in 1990, so inflation alone only accounts for rent rising to around $900 today.
In fact, rent consistently proves one of the most significant drivers of inflation. That makes rental properties a prime investment to combat inflation.
Pro tip: An easy way to invest in rental properties is through a company like Roofstock.
Real Estate Investment Trusts
Real estate investment trusts (REITs) are investment funds that invest, either directly or indirectly, in real estate.
Equity REITs directly own and operate real estate investments, whether residential, commercial, industrial, or any other type of property. Mortgage REITs, or mREITs, invest indirectly through real estate-secured loans.
Further distinctions arise between publicly traded REITs and private REITs. Public REITs trade on stock exchanges like exchange-traded funds (ETFs) or mutual funds, and anyone can buy them through their brokerage account. Per regulations by the SEC, publicly traded REITs must return at least 90% of their profits to investors in the form of dividends. That creates a double-edged sword. Public REITs tend to have high dividend yields, but they struggle to grow their portfolios without being able to reinvest much of their profits.
Private REITs don’t operate under the same regulation. The fund issues shares directly to investors and decides for itself how much profit to reinvest versus pay out in dividends to shareholders. While some investors feel less comfortable with the leaner oversight, others enjoy the strong returns offered by firms such as Fundrise and Streitwise. Just start small and only scale up as you become more comfortable with them.
Despite being paper assets, real property secures REITs, and their returns tie directly to real estate values and rents. That affords them similar inflation protection to direct real estate ownership.
Short-Term Loans Secured by Real Estate
While many real estate crowdfunding websites operate private REITs, not all follow that model.
Some allow investors to lend money toward specific loans by individual real estate investors. You get to review the details of the loan and invest as much or as little as you like toward it.
In many cases, these are hard-money loans: short-term purchase-rehab loans taken out by house flippers. They tend to pay high interest rates in the 6% to 14% range, which provides some protection against inflation in itself.
But the real inflation advantage lies in two other factors. First, the loans are short-term, so inflation runs rampant, your money isn’t tied up for long at yesterday’s low interest rates. You get your money back quickly and can reinvest at the higher rates typical in an inflationary environment.
Second, because real estate secures the loan and real estate usually keeps pace with or exceeds inflation, inflation actually helps the real estate investor sell their home for more than they borrowed. That boosts the odds they pay the loan back on time and in full.
Buy a Home
Homeowners with fixed-interest mortgages are protected against inflation, at least for their housing costs. More than protected — inflation helps them by reducing the value of each month’s mortgage payment.
Renters enjoy no such protection. They can expect rents to rise each year alongside inflation — perhaps even faster.
Still, be careful of confusing your home with a true investment. Housing is a living expense, not an investment. Living expenses cost you money, and the less you spend on them, the richer you become. Investments earn you money, and you get richer by pumping more into them, not less.
Too many homebuyers justify overspending on a home by glibly telling themselves that their swanky new home is an “investment.” So while homeowners do gain protection from inflation from ownership, take care to remember it still represents an expense in your budget.
Commodities are physical items with inherent value. They range in diversity from metals like copper to energy like crude oil and natural gas and from lumber to food staples like grain, sugar, and coffee.
People want and need them in the course of everyday life, making demand relatively stable. So no matter what currency they sell in, or the value of that currency, their pricing adjusts based on the market fundamentals of supply and demand. When the dollar loses value, the prices of these staples typically rise to compensate.
Since you probably don’t want to store actual sheets of copper or barrels of corn in your basement, you can invest in commodities through funds in your brokerage account. You have plenty of options for commodity ETFs and mutual funds, although the simplest broad exposure to commodities comes from commodity index funds.
A commodity index fund works just like any other index fund. It can be purchased through a brokerage like TD Ameritrade and it mirrors a market index — in this case, a commodity market index, which tracks a single commodity, a group of similar commodities, or the commodity market as a whole. For a broad commodity index fund, try the Invesco DB Commodity Index Tracking Fund (DBC), which tracks the Deutsche Bank Commodity Index.
3. Gold & Precious Metals
While technically, precious metals like gold fall under the category of commodities, they hold a special place in the world of inflation protection.
For thousands of years, civilizations around the world used precious metals as the basis for their currencies. Initially, the physical money itself was made from these metals in the form of coins. Later, central banks tied paper currency to real gold in their vaults.
That changed in the late 19th and early 20th centuries. But to this day, precious metals remain a fallback anchor whenever citizens doubt or distrust a paper currency.
When inflation looms, investors flock to gold, sending prices skyrocketing. Precious metals also make for a relatively recession-proof investment, as market turmoil leaves paper assets in freefall while gold retains its value.
Gold tends to do poorly in bull markets, but investors consider it a safe fallback in times of strife.
If you’re looking to add gold to your portfolio, Vaulted allows you to invest in 99.99% pure gold bars.
4. Investment-Grade Art
While less talked about than real estate and commodities, fine art serves as another physical asset with value. A masterpiece painting by Van Gogh, for example, simply commands higher pricing in lower-value currencies. It has its own intrinsic value.
The average American can’t afford such a masterpiece. But in today’s world, investors can invest in fractional shares of art deals through platforms like Masterworks.
It works similarly to crowdfunded real estate investments: You buy shares in verified fine artworks and earn your return when those pieces sell.
Though not without its own risks, from uncertain returns to poor transparency, investing in fine art does offer another option for protecting against inflation by buying real assets.
5. Treasury Inflation-Protected Securities
Physical or real assets aren’t the only type of investment to survive inflation intact.
The Treasury Department issues a special type of bond expressly designed to protect against inflation. Treasury inflation-protected securities, or TIPS, adjust in value directly based on inflation.
Like regular bonds, they pay a fixed interest rate, and you can buy and sell them on the open market. But unlike regular bonds, the principal amount changes to reflect inflation.
Say you buy a TIPS bond for $1,000, and it pays 3% annual interest, or $30 per year. If inflation surges 5%, ordinarily, you would lose money on a 3% interest bond. But TIPS adjust the principal amount of your bond up 5% to $1,050 and pay your interest based on that higher amount. So instead of $30 per year, the TIPS would pay you $31.50.
When TIPS mature, they pay you back the new principal amount as the face value rather than what you originally paid for them. Unless the dollar experienced deflation, in which case you get back your original purchase price.
Don’t expect to get rich investing in TIPS. They tend to pay extremely low interest rates, given the additional protections and the backing of the U.S. Treasury Department. But they do protect you against inflation, at least.
6. Growth-Oriented Stocks
First, it’s worth noting that growth-oriented stocks are stocks for which the appeal comes from the potential for price gains rather than income-oriented stocks that pay high dividends. It has nothing to do with growth versus value stocks.
Companies that can raise prices alongside inflation tend to weather inflationary periods safely. For example, even if food companies’ raw material costs rise during inflation, they can typically pass those price hikes along to their customers without blowback.
The same logic applies to many industries that provide essential services. As with commodities, people pay the going rate for essential items, even if inflation causes pricing to jump as the value of each dollar falls. Some industries that typically survive just fine during inflationary periods include:
- Health care
- Building materials
As long as these companies can raise prices with inflation and maintain their profits, their stock price should also rise alongside that inflation.
Income-oriented stocks paying a strong dividend tend not to do as well, as dividends often fail to keep pace with inflation. Dividend investors also get hit with regular income taxes on those dividends, further reducing the real value of those dividends.
No one really knows how cryptocurrencies fare during hyperinflation. They simply haven’t existed long enough for sound data.
But cryptocurrencies do have a few advantages over government-backed fiat currencies (those not backed by gold or other real commodities). First, governments looking to manage their debt by printing more money don’t manipulate cryptocurrencies.
Instead, the money supply of cryptocurrencies depends on their own stated logic. For instance, the new supply of bitcoin slows over time. Originally, anyone could “mine” new bitcoins at a rate of 50 every 10 minutes. The mining process involves contributing your own computing power to the public bitcoin ledger. But every four years, that new coin creation halves. In 2012, it dropped to 25 bitcoins every 10 minutes, then in 2016, it dropped to 12.5, and in 2020, it dropped to 6.25.
So while supply continues to grow, it does so at a slower rate over time. That creates upward pressure on the value of each unit.
The problem with cryptocurrencies is that the underlying value of them isn’t clear. There is some inherent value in an anonymous currency not controlled by any government. But no one knows precisely what that is.
That makes cryptocurrencies more speculation than investment. If you’re interested in using crypto to protect against inflation, you can get started through Robinhood.
8. Convert Your Debts From Variable to Fixed Interest
Wait, aren’t debts the opposite of investments?
They are. But debt management plans remain just as important in the grand scheme of your finances as investing plans.
During periods of rampant inflation, the Fed typically raises interest rates to slow it. That also keeps the banking system afloat. If interest rates don’t exceed inflation, lenders lose money.
Borrowers with adjustable interest rates can expect their rates to rise if hyperinflation strikes. Meanwhile, borrowers with fixed interest rates rejoice because the value of each debt payment shrinks along with the dollar.
In 1990, $1 was worth the equivalent of $2 today. A $500 monthly mortgage payment back then cost you the equivalent of $1,000 today. But 30 years later, you’d still be paying the same nominal $500 per month, which means half as much to you today as it did 30 years ago.
If you worry that inflation will hit, consider refinancing your adjustable-rate debts to fixed interest through Credible.com. You lock in both today’s low interest rates and monthly payments at today’s currency pricing, so as that currency loses value, the real cost of those payments drops with it.
What to Avoid Before Inflation
In a word: bonds.
Just as you want to borrow money at fixed interest rates during inflation, you don’t want to lend money at fixed interest. That’s effectively what bonds are: loans at fixed interest rates, whether to governments or corporations.
If you buy a bond paying 4% per year, and inflation surges at 5%, you effectively lose 1% in real dollars each year. And that means no one will want to buy them, either.
Remember, when interest rates rise, the price of existing bonds goes down. So when interest rates surge to manage runaway inflation, your existing bonds — that pay low interest — plummet in value on the secondary market. If you worry that inflation lurks around the corner, talk to your investment advisor about potentially reducing your exposure to bonds.
As effective as many investments are during inflation, don’t forget about the most crucial investment: yourself.
Your continued ability to earn money — regardless of the currency denomination — remains your greatest asset. In bull markets and bear, periods of turmoil or stability, you must continue to earn a paycheck. The more value you bring to employers or your clients, the better you protect your finances against shocks like hyperinflation.
Pursue ongoing education, certifications, licenses, and professional credentials. Invest time in networking. Position yourself well in the good times so you can weather the bad times.
Also keep in mind that investments only make up one side of the inflation equation. You should also consider lifestyle changes to protect against inflation. You build wealth in direct proportion to your savings rate. Save more, invest more, diversify, and accumulate real wealth rather than the trappings of wealth, such as impressive houses and cars.
If you can continue earning a healthy, inflation-adjusted income while holding your expenses in check, you maintain financial stability even if inflation dents your portfolio. Invest in yourself.
What investments do you like for protecting against inflation? Why?