If your wallet feels a little lighter recently, there’s likely a reason—the cost of your purchases may have ticked up. The Consumer Price Index (CPI), which measures prices across a basket of goods and services, increased in January. The Producer Price Index (PPI), which measures prices from the seller’s end, showed strong gains as well.
On the plus side, higher prices are typically indicative of a growing economy. Less positive for consumers is that their dollars may not go as far as they did just a few months ago.
It’s been a while since the market had to contend with inflationary pressures. If history is a guide, though, it usually doesn’t take much for inflation fears to ratchet up (see the recent market volatility). For investors starting to explore ways to offset higher prices, there’s no such thing as a perfect inflation hedge, especially over the short term. So it may make sense to explore several different strategies, a few of which we outline below.
Source: US Bureau of Labor Statistics
Possible inflation hedges may actually be in your portfolio already. Though investors seem to overlook equities when inflation rises, many companies can pass through higher prices to consumers. Companies specializing in essentials come to mind—prices may rise, but people still need toothpaste to brush their teeth and medicine to make them feel better.
Shareholders of companies able to keep their pricing on pace with inflation may benefit from an increase in profitability by way of dividends, share buybacks, or higher equity values.
Demand for commodities typically spikes amid economic growth. And as demand goes, so do prices. For example, oil is thought to be a popular inflation hedge. Cost increases make their way to the consumer through gasoline prices, as well as goods that require transport. It’s less than practical to buy and store a barrel of oil, so some investors seek exposure through commodity-based companies or commodity-focused exchange-traded funds.
Of course, one of the oldest hedges for rising inflation is gold. The yellow metal, which is mined like other commodities but behaves more like a monetary asset, may not be the all-encompassing inflation hedge it’s often thought to be. Gold doesn’t provide coupon payments or dividends, but it can function as a store of value.
Real estate investment trusts
As prices rise, the resale value of owned property can rise too. Another factor in utilizing real estate as an inflation hedge is rental income. The amounts tenants are charged can increase over time to keep pace with rising prices.
Investing in physical real estate takes some doing and is, obviously, a less liquid option. Some investors look toward real estate investment trusts (REITs). As inflation increases rent prices, there is the potential for more cash flow to be passed along to shareholders via dividends and buybacks. Rising interest rates can be a headwind for REITs, but an accelerating economy may be able to mitigate that rate risk for certain REITs, particularly those involved in infrastructure properties.
Treasury inflation-protected securities
One asset that can offer some defense is a bond indexed to inflation. Treasury inflation-protected securities (TIPS) are pegged to the CPI. When the index rises, so does the investment in TIPS. And it’s not just the base value that increases. The interest payment, which is based on the base value, increases too.
Notable, however, is that rising interest rates can be a headwind for TIPS. A catch is that they generally have long durations and can be susceptible to price volatility when interest rates jump quickly. TIPs could also lose value during deflationary periods.
On the bright side
Instead of worrying about inflation, it may be worth seeing it as the next step in the economy normalizing. For its part, the Federal Open Market Committee has been waiting quite some time for its preferred inflation measure, the annual change in the price index for personal consumption expenditures, to rise to its 2% target. As the Fed says, at least a small level of inflation makes deflation, which brings with it the potential for not only falling prices but lower wages as well, less likely.1
For investors, the recent inflationary signals could be a good opportunity to reassess, rebalance, and round out their portfolios with some additional diversification.
1. “Why does the Federal Reserve aim for 2 percent inflation over time?” https://www.federalreserve.gov/faqs/economy_14400.htm