Top Strategies for Savvy Investors

Inflation erodes the purchasing power of money, which means the same amount buys less over time, and it can also impact the returns on investments. Some asset classes, such as real estate and commodities, have historically offered protection against rising prices.

Keep reading to get practical investment tips to help manage and benefit from inflation by focusing on areas like real estate, commodities, bonds, and stocks. Discover strategies and learn how to protect and grow your assets.

Inflation Measurement: Essential Metrics and Tools

Inflation measures how prices for goods and services change over time. It is expressed as a rate in percentage form and indicates how much prices have changed from the last time it was measured. Moderate inflation seems counterintuitive, but it helps the economy by boosting growth, lending, and borrowing.

The U.S. Federal Reserve targets a 2% average inflation rate over time as most consistent with its dual mandate in promoting price stability and maximum employment. Agencies select specific goods and services to calculate the inflation rate.

Inflation Indicators: Key Economic Measurements

The most common economic measurements used to gauge inflation are the Consumer Price Index (CPI), the Producer Price Index (PPI), and the Personal Consumption Expenditures (PCE) Price Index:

• The CPI measures the weighted average that urban consumers pay for a standardized market basket of goods and services. It is reported monthly by the Bureau of Labor Statistics (BLS).
• The PPI is a weighted average of prices realized by domestic producers. It includes prices from the first commercial transaction for many products and some services. It is also reported monthly by the BLS.
• The PCE Price Index is the Federal Reserve’s preferred inflation gauge. The PCE is a broader measure than the CPI and is weighted based on consumption measures used to derive the gross domestic product rather than on a household spending survey as the CPI. It is released monthly by the Bureau of Economic Analysis of the U.S. Department of Commerce.

All three of these indexes provide an alternative “core” reading, excluding the more volatile food and energy prices. Another alternative inflation measure is the Trimmed Mean PCE Price Index from the Federal Reserve Bank of Dallas, which excludes spending categories with the most extreme price moves in either direction from each monthly calculation.

Top Investments to Protect Against Inflation

While inflation’s impact is uncertain, history and economics provide useful guidelines.

Inflation is most damaging to the value of fixed-rate debt securities because it devalues interest rate payments as well as repayments of principal. If the inflation rate exceeds the interest rate, then lenders are, in effect, losing money after adjusting for inflation. This is why investors sometimes focus on the real interest rate, derived by subtracting the inflation rate from the nominal interest rate.

The assets that fare best under inflation are those assured of bringing in more cash or rising value as inflation increases. Examples include rental properties that raise rent and pipelines with inflation-linked rates.

Real Estate as an Inflation Hedge

Real estate is a popular choice because it becomes a more useful and popular store of value amid inflation while generating increased rental income.

Investors can buy real estate directly or invest in it by purchasing shares of a real estate investment trust (REIT) or specialized fund.

Real estate performed well during the persistent inflation of the 1970s. But real estate is also vulnerable to rising interest rates and financial crises, as seen in 2007–2009.

Profiting with Commodities During Inflation

As inflation rises, investors seek tangible assets likely to gain value.

For centuries, the leading haven has been gold—and, to a lesser extent, other precious metals—causing prices to rise as inflation rises. You can buy gold directly from dealers or invest in mutual funds or exchange-traded funds (ETFs) that hold gold. Investors can also get exposure to a commodity by purchasing shares of the companies that produced it directly, or indirectly through an ETF or specialized mutual fund.

Commodities include raw materials and agricultural products like oil, copper, cotton, soybeans, and orange juice. Commodity prices tend to rise alongside the prices of finished products made from those commodities in inflationary environments.

For example, higher crude prices elevate the price of gasoline and transportation. Sophisticated investors can trade commodities futures or the shares of producers. On the other hand, exchange-traded funds investing in commodity futures will tend to underperform the price of a rising commodity because their futures positions must be rolled as they expire.

Bonds: Navigating Inflation with Secure Returns

Investing in bonds may seem counterintuitive, as inflation is typically harmful to fixed-rate debt. That’s not the case for inflation-indexed bonds, which offer a variable interest rate tied to the inflation rate. In the United States, Treasury Inflation-Protected Securities (TIPS) are a popular option, pegged to the Consumer Price Index.

When the CPI rises, so does the value of a TIPS investment. Not only does the base value increase, but since the interest paid is based on the base value, the interest payments also increase with the base value increase. Other varieties of inflation-indexed bonds are also available, including those issued by other countries.

Inflation-indexed bonds can be accessed in a variety of ways. Direct investment in TIPS, for instance, can be made through the U.S. Treasury or a brokerage account. They are also held in some mutual funds and exchange-traded funds. For a more aggressive play, consider junk bonds. High-yield debt—as it’s officially known—tends to gain in value when inflation rises, as investors turn to the higher returns offered by this riskier-than-average fixed-income investment.

Investing in Stocks: Thriving Through Inflation

Stocks have a reasonable chance of keeping pace with inflation—but when it comes to doing so, not all equities are created equal. For example, high-dividend-paying stocks tend to get hammered like fixed-rate bonds in inflationary times. Investors should focus on companies that can pass their rising input costs to customers, such as those in the consumer staples sector.

Leveraged Loans and Debt: Strategies for Inflation Protection

Leveraged loans are potential inflation hedges as well. They are a floating-rate instrument, meaning that the banks or other lenders can raise the interest rate charged so that the return on investment (ROI) keeps pace with inflation.

Mortgage-backed securities (MBS) and collateralized debt obligations (CDOs)—structured pools of mortgages and consumer loans, respectively—are also an option. Investors do not own the debts themselves but invest in securities whose underlying assets are the loans.

MBS, CDOs, and leveraged loans are sophisticated, somewhat risky (depending on their rating) instruments, often requiring fairly large minimum investments. For most retail investors, the feasible course is to buy a mutual fund or ETF that specializes in these income-generating products.

Investing During Inflation: Benefits and Risks

There are pros and cons to every type of investment or hedge. The primary benefit of investing during inflation is to preserve your portfolio’s value. The second reason is that you want to keep your nest egg growing, even if it’s at a slower rate.

Accepting inflation as part of a growing economy can guide you to diversify holdings to balance gains and losses.

Diversifying risk across different holdings applies to both inflation-fighting and growth strategies.

The Bottom Line

Diversification during inflation can help you spread your portfolio across assets. Assets like real estate, commodities, TIPS, and select stocks can help protect your wealth. Don’t overreact to short-term inflation spikes because staying focused on your long-term goals serves you better than making hasty shifts.

While these asset classes have offered some protection, no strategy is guaranteed, and market conditions can change unpredictably. Avoid concentrating too heavily in a single investment, and maintain a balanced approach to reduce risk during inflationary periods.