Inflation Protection
What can you do to protect yourself from the price of things going up? As a follow up to our last blog post, we want to give some thought to the topic of inflation protection.
Let’s first say we are not convinced that inflation is in fact an imminent threat. However, the Federal Reserve at its last meeting and press conference outlined a change in strategy that some are calling historic, according to recent reporting from CNBC. In a nutshell, the Fed is now targeting “average inflation of 2%” – which means they would be willing to let the economy grow faster without raising interest rates for some period of time and overshoot the target to get to an average annual percentage. There’s no guarantee the economy will get there anytime soon but this is a significant change in monetary policy.
Here’s another important fact: for investors, inflation expectations are more important than actual inflation. This means the trend is more important than an absolute number. And of course, that is part of the mentality investors should always employ. Like Gretzky said, “skate to where the puck is going to be.”
So the question can be asked, how do we position ourselves for inflation? Looked at from a certain point of view, the act of investing could be considered as an attempt to overcome inflation. As investors, we don’t like lazy money. If our savings are not working for us, we know they’ll be overtaken by the forces of inflation. But there are particular investments that do better in an inflationary environment.
TIPS – Treasury Inflation Protected Securities help eliminate inflation risk to your portfolio as the principal is adjusted semiannually for inflation based on the Consumer Price Index – while providing a real rate of return guaranteed by the U.S. Government
Commodities – a key component of the hard assets category of investments, commodities include precious metals like gold and silver, agriculture-related investments, timber and other natural resources. Keep in mind, the fast price swings in commodities and currencies may result in significant volatility in an investor’s holdings depending on the overall allocation.
Real estate – although direct ownership of real estate, like a rental property, is what most often comes to mind, there are a number of ways to get exposure to real estate investments in more liquid forms like listed REITS, real estate investment trusts.*
Foreign stocks – generally speaking, all stocks are a decent inflation hedge because they will often grow faster than inflation, but should we end up in an inflationary environment here in the US, the dollar will typically suffer when compared to other currencies and that becomes a tailwind for foreign stock exposure, according to data from the National Bureau of Economic Research.**
None of these asset classes by themselves provide a silver bullet for an inflationary environment, but as part of a proper asset allocation, the addition of some of these alternatives can provide improved diversification and help with offsetting the negative effects of inflation should they become an increased factor.
*Investing in Real Estate Investment Trusts (REITs) involves special risks such as potential illiquidity and may not be suitable for all investors.
**International investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.