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by Stella Ong
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What are the best investments to hedge against inflation?

Rising inflation has been a major concern for investors worldwide. Learn how to protect your portfolio against it and maybe even profit from rising inflation.

Here are the most common investments to hedge against inflation

Stocks

Investing in the stock market can be an effective way to hedge against inflation. During inflationary periods, companies may raise their prices to keep up with rising costs, leading to increased revenues and potentially higher stock prices.

Stocks have historically outpaced inflation over the long term, offering the potential for capital appreciation. It's essential to focus on companies with strong fundamentals, pricing power, and sustainable competitive advantages to better withstand inflationary pressures. Diversifying across various sectors and industries can help mitigate specific risks and enhance the overall inflation-hedging potential of a stock portfolio.

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Exchange-traded funds

Exchange-traded funds offer a convenient way to gain exposure to a basket of assets that can act as a good inflation hedge. Inflation-focused ETFs might include holdings in inflation-protected bonds (TIPS), commodity-based funds, real estate investment trusts (REITs), and even stocks of companies that tend to perform well during inflationary periods.

These ETFs can provide diversification benefits and allow investors to capitalise on multiple inflation hedges within a single investment vehicle with low operating costs. As with any investment, it's essential to research the underlying holdings and understand the specific strategies of the ETFs before investing.

Gold

Gold is often considered a classic inflation hedge due to its historical track record of retaining value during economic uncertainties and inflationary periods. As a precious metal, gold tends to retain its purchasing power over time, especially during times of currency depreciation. Investors often view gold as a safe-haven asset, seeking it as a store of value and a hedge against currency devaluation.

While gold can be volatile in the short term, it has shown a tendency to hold its value over the long run, making it an attractive addition to a diversified portfolio seeking protection against a rising inflation rate. Buying physical gold is not an option on Stake but you can still use this precious metal as an investment to hedge against inflation through gold stocks and gold ETFs.

REITs

Real estate investment trusts (REITs) are companies that own and manage income-generating properties such as commercial real estate, apartments, and shopping centres. REITs can serve as an inflation hedge because they have the potential to raise rents in response to inflation, leading to increased cash flow and potentially higher returns for investors.

Real estate is a tangible asset that tends to appreciate over time, providing a potential store of value. However, it's crucial to consider the specific market conditions and the quality of the underlying real estate assets when investing in REITs, as some sectors may be more resilient to inflation than others.

Bonds

While traditional fixed-rate bonds may not be the best inflation hedge, certain types of bonds can offer protection against rising prices. Inflation-protected bonds, such as Treasury Inflation-Protected Securities (TIPS), adjust their principal value with inflation, providing investors with a guaranteed real return. These bonds can offer a hedge against inflation by preserving the purchasing power of the invested capital.

However, investors should be mindful of interest rate risk and ensure that the yield on inflation-protected bonds is attractive relative to other inflation-hedging assets.

Some examples of TIPS include $TIP and $SPIP.

Cash

Holding cash during inflationary periods might seem counterintuitive as it may lose value in real terms.

However, having some cash reserves can offer flexibility and liquidity to take advantage of investment opportunities that may arise during periods of uncertainty or market volatility. Short-term government bonds or money market funds can provide a safe place to park cash while earning some interest that may help offset the impact of inflation.

Commodities and other precious metals

Investing in commodities like oil, natural gas, agricultural products, and other precious metals (e.g., silver, platinum) can provide a hedge against inflation. As the prices of these tangible assets tend to rise with inflation, they can offer protection for investors' purchasing power. Commodities can be accessed through commodity-focused ETFs, futures contracts, or by directly investing in physical assets.

However, it's crucial to consider supply and demand dynamics and potential volatility in the commodity markets when incorporating them into an investment strategy.

What are the worst investments during inflation?

During inflationary periods, certain investments may underperform or lose value due to decreased purchasing power. Here are some investments that are generally considered to be less favourable during inflation:

  • Bonds with a fixed interest rate: Traditional fixed-rate bonds, especially those with long maturities, can lose value during inflation. As inflation rises, the fixed interest payments become less attractive if interest rates rise and newly issued bonds offer a higher yield.
  • Long-term government bonds: Long-term government bonds are particularly vulnerable to inflation because their fixed interest payments may not keep up with rising prices, leading to a decrease in their real value.
  • Low-yield bonds: Bonds with low yields, such as investment-grade bonds, may not offer sufficient returns to offset the impact of inflation.
  • Consumer discretionary stocks: Companies in consumer discretionary sectors, such as luxury goods or travel, may face challenges during inflation as consumers cut back on non-essential spending.
  • Stagnant or declining industries: Companies in industries unable to pass on increased costs to consumers may struggle during inflation.

What assets have been the best hedge against inflation historically?

Historically, assets such as gold, real estate, TIPS (Treasury Inflation-Protected Securities), commodities, stocks of inflation-resistant companies, infrastructure investments, and high-yield bonds have been considered effective hedges against inflation due to their ability to preserve value or even appreciate during inflationary periods.

However, each asset class comes with its own set of pros, cons, and risks, and there is no single "best" hedge against inflation nor a perfect inflation hedge. Diversification across multiple inflation hedges and careful consideration of individual circumstances is crucial when constructing an investment portfolio to protect against the erosive effects of inflation.

What are the pros and cons of investing in inflation-proof assets?

Investing in inflation-proof assets, also known as inflation hedges, can be a strategy to protect your wealth from the erosive effects of inflation. Here are the pros and cons of investing in such assets:

Pros

Preservation of purchasing power: Inflation-proof assets have the potential to maintain or increase their value in real terms, helping to protect your portfolio as money loses purchasing power over time.

Diversification benefits: Including inflation hedges in your investment portfolio can provide diversification benefits. These assets may perform differently from traditional investments like stocks and bonds, reducing overall portfolio volatility.

Hedge against uncertainty: Inflation can be unpredictable, and investing in assets that historically perform well during inflationary times can act as a hedge against economic uncertainty.

Protection for fixed-income investors: Inflation can erode the value of fixed-income investments, but inflation-protected securities can provide a degree of security for bondholders.

Potential for capital appreciation: Certain assets, such as commodities and real estate, may not only protect against inflation but also appreciate in value during inflationary periods.

Cons

Market risk: Like any investment, inflation-proof assets are not immune to market risk. Their prices can still fluctuate based on various factors, including supply and demand dynamics and changes in market sentiment.

Volatility: Some inflation hedges, such as commodities and certain stocks, can be subject to high volatility, which may not be suitable for all investors.

Opportunity cost: Allocating a significant portion of your portfolio to inflation-proof assets might result in missed opportunities if other sectors or asset classes perform better during non-inflationary times.

Limited supply: Some inflation hedges, like precious metals, have limited supply, which can make them susceptible to price manipulation or sudden price swings.

Complexity and lack of liquidity: Some inflation hedges, such as certain types of real estate investments or exotic derivatives, can be complex and illiquid, making them challenging to buy or sell at desired times.

Regulatory and political risks: Certain inflation-proof assets, like commodities or foreign investments, may be subject to regulatory changes or geopolitical risks, impacting their performance.

Overall, investing in inflation-proof assets can be a valuable component of a well-diversified investment strategy, especially during periods of heightened inflation expectations.

Can Bitcoin be an inflation hedge?

Bitcoin is often considered by some investors and analysts as a potential inflation hedge, but whether this will hold true is highly controversial. The argument for Bitcoin as an inflation hedge stems from its unique characteristics, including its limited supply and decentralised nature. With a fixed supply capped at 21 million coins, Bitcoin is inherently deflationary, making it less susceptible to the effects of inflation compared to fiat currencies.

Its decentralised nature also means it is not controlled by any central authority, reducing concerns about government policies that may contribute to inflation. Some proponents view Bitcoin as a store of value asset, similar to gold, and believe that its growing adoption as such could make it an attractive option for investors seeking protection against inflation.

However, it's important to acknowledge that it didn’t provide protection against rising inflation since the Covid-19 pandemic, raising concerns that if it is to be an inflation hedge, it could only work as a hedge for hyperinflation, not being able to hedge against ordinary inflation rises. Bitcoin's value is also still heavily influenced by speculation and sentiment, and it can be highly volatile in the short term.

While you can't buy Bitcoin on Stake, there is still an option to invest in the Bitcoin ETFs like $EBTC, if this is an asset you intend to use as a hedge against inflation.

This does not constitute financial advice nor a recommendation to invest in the securities listed. The information presented is intended to be of a factual nature only. Past performance is not a reliable indicator of future performance. As always, do your own research and consider seeking financial, legal and taxation advice before investing.


Portrait photo of Stella Ong, Markets Analyst at Stake.

Stella Ong

Markets Analyst

Stella is a markets analyst and writer with almost a decade of investing experience. With a Masters in Accounting from the University of Sydney, she specialises in financial statement analysis and financial modelling. Previously, she worked as an equity analyst at Australian finance start-up, Simply Wall St, where she took charge of the market insights newsletter sent out to over a million subscribers. At Stake, Stella has been key to producing the weekly Wrap articles and social media content.


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