Investing

Best Investments During Inflation: 3 Ideas

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When inflation rises, chances are that you’ll feel it at the grocery store, the gas pump and everywhere in between — including your investments.

So what are the best investments during inflation-addled times?

Investment classes like real assets, inflation-protected bonds and certain stocks can all help you diversify your portfolio and protect your purchasing power. And MagnifyMoney is here to help you understand each and the role they could play in your investment strategy.

What is inflation?

Inflation is how much prices have risen during a set period. For example, in the U.S., the Consumer Price Index (CPI) tracks how much key items have increased in price over 12-month periods and identifies how the cost of food, energy and other essentials has changed.

Inflation most typically occurs when demand outpaces supply, which pushes prices higher across the board. After all, if buyers want items in short supply, sellers will charge more for their current inventory so they don’t lose money. In turn, those higher prices decrease your everyday purchasing power.

And here’s the thing about inflation: No one is immune to its effects, but some people feel the impacts more than others. Retirees, marginalized communities and those living on fixed incomes tend to bear the brunt of rising prices.

How inflation impacts your investments

Inflation doesn’t just erode the purchasing power of your cash — it also quietly eats away at your portfolio’s rate of return. For example, imagine you had $100,000 invested in a portfolio that grew by 10% over the last year. Not bad, right?

Your gains don’t seem as robust after adjusting for inflation, which remained at 8.5% in July 2022. In the example above, your portfolio’s real rate of return would have been just 1.5%.

As an investor, you want to have dollars allocated to assets that can keep pace with inflation or surpass it. Of course, stocks are more likely to do that than cash, but tangible assets and inflation-protected bonds can be better suited to inflationary environments.

Real assets: commodities, real estate and infrastructure

Not all investments are created equal in an inflationary environment. Real assets like commodities and real estate have historically outperformed other asset classes when inflation rises gradually or spikes unexpectedly.

But what are real assets, and what sets them apart from financial assets, like stocks and bonds?

  • They’re tangible and have a practical application. Real assets can be raw materials like oil, timber and gold or physical structures like an apartment building or a bridge.
  • They help power our economy. Real assets are essential in producing other goods and services, which gives them value.
  • They typically rise in value as other prices increase. This makes real assets a worthwhile long-term addition to your investment portfolio because they can keep pace with inflation.

So how do you invest in real assets? Consider these options:

Commodities

Commodities are the goods and resources used to make products and services. Oil, natural gas, metals, grain, corn, livestock and even coffee are all examples of commodities.

Commodities are also investment assets with inflation protection. When the price of a product increases due to rising demand, so will the price of the underlying commodities used to create that product. As a result, commodities typically benefit from inflation.

You have several options for adding commodities exposure to your portfolio:

  • Buy physical gold or other precious metals online. You can get them shipped to you, but you’ll have to figure out how to store them safely (either in your home, at a bank or at a precious metals depository).
  • Trade commodity futures. Futures contracts are agreements to buy or sell a commodity for a set price at a specific time.
  • Invest in commodity funds. You can also gain exposure to commodity futures or physical assets through mutual funds and exchange-traded funds (ETFs).

Real estate

Real estate has historically offered protection against inflation. This is because property values typically increase over time, and some real estate produces income.

Take an apartment, for example. The property’s value can increase as general property prices increase. The owner can also increase the rent each time they renew the lease, allowing them to keep pace with inflation.

Types of income-producing real estate:

  • Residential properties
  • Commercial properties
  • Industrial warehouses
  • Self-storage facilities
  • Vacation homes
  • Hotels
  • Farmland

Beyond purchasing a building or a piece of land, you can also invest in real estate indirectly through real estate investment trusts (REITs). These companies, some of which are traded publicly on stock exchanges, own and operate income-producing properties like apartment complexes or self-storage facilities.

As an investor, you receive a share of the profits the REITs’ properties generate. Like ETFs and mutual funds, REITs come in different varieties. Some invest in residential properties, while others focus solely on commercial real estate.

Infrastructure

The last time you traveled over a bridge or through a tunnel, you probably weren’t thinking of it as a potential investment. But infrastructure is expensive to build, and governments often look to the private sector for help funding these projects.

Why invest in infrastructure? Bridges, roads, tunnels and other types of infrastructure produce stable, predictable cash flows because their use is critical to everyday life. However, as operational costs increase with inflation, these assets can also pass the higher costs onto the public by hiking tolls and fees.

Other types of infrastructure:

  • Railroads
  • Airports
  • Ports
  • Water systems
  • Data centers
  • Utilities
  • Pipelines

Of course, you can’t just buy a bridge yourself. Investors seeking exposure to infrastructure have these two options:

  • Invest in infrastructure mutual funds and ETFs. Although, doing so may not provide the same level of inflation protection as private ownership since these securities are correlated more closely with traditional stocks, which are more sensitive to inflation.
  • Invest in unlisted infrastructure assets. Investors can pool their money to purchase infrastructure assets or buy shares of unlisted funds that buy and sell such assets.

Inflation-protected bonds

Bonds may not immediately come to mind, but specific fixed-income instruments protect your principal and preserve your purchasing power during inflation.

Series I Savings Bonds and Treasury Inflation-Protected Securities (TIPS) offer inflation protection through interest rates that rise and fall with the CPI. Yet, there are some key differences to consider before investing in either:

 Series I BondsTIPS
Term30 year only5, 10, 30 year
How you make moneyFixed rate of return set at the time of purchase and an inflation rate that adjusts twice a yearFixed interest rate paid on principal value of bond, which increases with inflation but decreases during deflation
How interest gets paidAccrues throughout the bond's life but only paid when the bond is sold or reaches maturityTwice annually
Purchase limit$10,000 per year electronic; $5,000 per year paper$10 million per non-competitive bid; maximum of 35% of offering amount per competitive bid
Where to buyDirectly from U.S. Treasury through Treasury Direct or via annual income tax returnU.S. Treasury or on secondary market through banker or broker

Stocks

Lastly, stocks have long been viewed as an inflation hedge — at the very least, a better alternative to cash or bonds. This is because a company’s revenue and share price should presumably rise as inflation pushes prices higher.

However, inflation impacts companies and sectors in different ways. For example, businesses with pricing power and the ability to pass on higher expenses to the consumer may serve as better investments during inflation.

The best investments during inflation will always depend on your unique needs, not to mention the type of investment account you use to make the purchase. If you’re concerned about your portfolio — especially your retirement savings — keeping pace with inflation, consider sitting down with a financial advisor. You might find incredible value in having a trusted financial expert invested in your success throughout every economic cycle.

Frequently asked questions

Inflation occurs when prices rise and the purchasing power of money falls. Inflation can result from increased demand for goods and services and insufficient supply. Meanwhile, if production costs for businesses increase, prices may rise and drive up inflation.

The Federal Reserve influences the flow of money into the economy using the federal funds rate, the interest rate that banking institutions pay to borrow money overnight. When the Fed raises this rate, it becomes more expensive to borrow money. With fewer people borrowing money, there’s presumably less demand for goods and services, reducing inflation.

It’s impossible to say for sure. Some believe rate hikes are enough to lower inflation without plunging the economy into a recession — two consecutive quarters in which gross domestic product falls. However, others fear rate hikes aimed at quelling inflation may propel the economy into a recession.

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