How to Inflation-Proof Your Investments

Record inflation, the likes we haven’t seen in forty years, is ravaging Americans’ pocketbooks. And, with its firm grip on the stock market, inflation is also having its way with investors’ portfolios. What was once thought to be a transitory phase now appears to be settling in for a more enduring economic condition that could last many months—well into next year or longer. Fortunately, there are ways investors can fortify their portfolios to mitigate the impact of inflation while seeking positive returns.

Time to Rethink Core Fixed Income Investments

Due to the prospect of higher inflation and rising interest rates, the long bull market in bonds is coming to an end. Core bonds are generating negative returns this year, and it’s only the beginning of what is likely to be a long period of interest rate hikes. In this environment, bonds cannot provide the kind of ballast to a portfolio as they have for decades. Investors who still want fixed-income exposure may be better off looking to alternatives such as inflation-protected, high-yield, or floating rate bonds. Exchange-traded funds such as XAI Octagon Floating Rate & Alternative income (XFLT) generate high yields with minimal volatility. Funds such as these invest in a wide range of fixed income and credit securities with one-year or less durations.

Other alternatives for income-seeking investors include equity-based funds that use a conservative options strategy, investing in large-cap stocks, and selling call options. For example, the JPMorgan Premium Income Fund (JEPIX) invests in a diversified portfolio of low-volatility stocks seeking to generate 7% to 9% in annual income from option premiums and stock dividends.

Another alternative is the inflation-sensitive, government-backed iBond which now yields 9.62%. iBonds must be held for at least one year.

Look to Commodities and Real Assets

Commodities and real estate tend to perform well under inflationary conditions because they are natural inflation eaters. The value of commodities, such as precious metals, industrial metals, agricultural products, and energy has historically kept pace with inflation. A number of factors are converging to drive commodity prices to their best returns in decades, including underinvestment, pent-up demand following the pandemic, the Ukraine war, and Russian sanctions. While commodities can be very volatile over the long term, all indications are these current forces will continue to drive prices for a while.

The best way for investors to participate in commodities is through ETFs. For example, investors who want to invest in metals can choose from a wide range of funds, such as SPDR Gold Trust, which tracks the price of gold bullion, or, for investing in energy, the Energy Select Sector SPDR fund, which invests in a portfolio of the top energy companies. Both these funds are up for the year. 

Real estate is also an excellent inflation hedge, with values actually exceeding the rate of inflation over the last five decades. Home values have increased more than 1,608% since 1970 compared to inflation which has increased by 644%. Investors can participate in growing real estate values and income by investing in real estate investment trusts (REITs). REITs invest in a diversified portfolio of commercial or multi-family residential properties. Investors can purchase REITs as they would an ETF on the stock exchange.

A big caveat for investing in commodity funds or REITs is they can be more complex. It’s critical to know what you are investing in before committing any funds.

Emphasize High-Quality Stocks

The performance of stocks during an inflationary environment tends to be mixed. Generally, capital-intensive companies with high debt and low profit margins tend to struggle when inflation rises. Low capital-intensive companies with low or no debt, higher gross margins, and increasing return on invested capital (ROIC) can perform well during high inflation periods. High-quality companies with strong brands and competitive advantages also have pricing power, which allows them to increase their prices with little or no impact on demand. Therefore, as consumer prices rise, so too do their revenues.

If you expect inflation to continue for some time, you may want to consider a rotation from economically sensitive companies, such as high tech or discretionary, into high-quality companies with the capacity to generate strong cash flow in any environment.

One of the worst moves to make is to abandon this declining market and hide your money in cash. Retreating to savings or money market accounts is the surest way to lose money in an inflationary environment. A CD or money market account earning 0.5% to 2% automatically loses 6% to 7% in value when inflation runs at 8%. It’s essential to have a sufficient amount of cash set aside for emergencies (3 to 6 months of living expenses), but beyond that, you’re better off staying invested and adjusting your portfolio to counter the impact of inflation.