Inflation presents special challenges to investors. Even if your investments are growing in value, inflation is still reducing that value on the backend. The only way to deal with it successfully is to be sure that your money’s in investments that are likely to benefit from inflation, while avoiding those that tend to be especially hard hit. Here are some ways to brace your investments for this situation.
Keep Cash in Money Market Funds or TIPS – With inflation now being officially invisible, interest rates are downright microscopic. If you suspect that inflation will be a factor in the future, it’s best to keep any cash type investments in money market funds. While it’s true that money market funds currently pay next to nothing, they’re the cash investment of choice during periods of rising inflation. When inflation hits, money market funds are interest-bearing investments, and that’s where you need to have your cash parked. Still another alternative is Treasury Inflation Protected Securities, or TIPS, issued by the US Treasury. You can buy these online through Treasury Direct in denominations as small as $100.
Avoid Long-term Fixed Income Investments – The worst investment to put money into, during periods of inflation, are long-term fixed rate interest-bearing investments. This can include any interest-bearing debt securities that pay fixed rates, but especially those with maturities of 10 years or longer. The problem with long-term fixed income investments is that when interest rates rise, the value of the underlying security falls as investors flee the security in favour of higher yielding alternatives. That 30-year bond that’s paying 3% could decline in value by as much as 40% should interest rates on newly issued 30-year bonds rise to 5%.
Emphasize Growth in Equity Investments – Many investors try to balance out their equity portfolios by investing in high dividend-paying stocks, or in growth and income funds, and this can work especially well during periods of price stability. But when inflation accelerates, it can hurt your investment returns. This is at least in part because high dividend paying stocks are negatively affected by rising inflation in much the same way long-term bonds are. The better alternative is to invest primarily in growth type stocks and funds. You should also emphasize sectors that are likely to benefit from inflation. These can include energy, food, healthcare, building materials and even technology. Since all are likely to rise in price with inflation, they’re likely to perform better than other equity sectors.
Commodities Tend to Shine with Inflation – While there isn’t an exact correlation between price levels and commodities, certain hard assets have traditionally been favoured by inflation. Precious metals come to mind immediately, particularly gold and silver. You can hold precious metals in direct form, with coins or bullion bars, but you can also invest indirectly through ETF’s that hold actual gold. You can also invest in gold mining stocks, or in funds comprised of these stocks. However, these are stocks, and not the actual metal itself. They also tend to be extremely volatile, even during times when gold prices are rising. A more predictable hold on the stock side will likely be energy stocks and funds. This is especially important since rising energy prices are often one of the primary drivers in inflationary environments.
Andro Ferraro 