There’s no doubt about it – inflation is rising. The latest report on Jun 10 was that inflation officially rose above 5%, year-on-year. This is the highest inflation we have seen in over a decade. While it’s not quite the baffling spike in inflation that many have been touting for the last year, it’s still going to have an effect on portfolio returns for investors.
Inflation is one of the quietest killers of capital gains in history. It is closely tracked and reported as a measure of an economy’s health – some inflation is good because rising prices means the economy is growing and improving the standards of living. However, no inflation points to no growth and “hyperinflation” points to an economy that is growing too fast in such a way that incomes and legislation can’t keep up.
To explain the effect of inflation on your investment, let’s use the rate of 5% that we have currently. If your portfolio only returned 5% between June 10, 2020 and Jun 10, 2021, the real return on your investment was 0% after you account for 5% inflation. In other words, you can calculate a real return after you subtract the inflation rate from your rate of return on investments. You would also subtract taxes from your investment returns to get real returns, but we’ll just focus on handling inflation in this article.
So, inflation is rising, and experts feel that it may be elevated for some time. How exactly are investors supposed to position their investments so that they can actually make money now?
The Oracle himself, Warren Buffet, has spoken on this quite often. His gift has always been to give the average investor wisdom in a few words when things get complicated. With inflation rising, Buffett’s recommendation is to keep investing in stocks. While the risk of interest rates may keep wild upward movements at bay, companies will still be able to benefit from rising prices.
Buffett managed to wade through the high-inflation periods of the 1970s and 1980s using similar tactics. He has commented on the dramatic effects of inflation as having the “…ability to simply consume capital.”
Real estate is sometimes a popular choice to invest in during high inflation periods. If you can handle the high buy-in requirement for physical real estate, then you may want to consider buying up rental properties to put on the market. However, with housing prices spiking, it may be difficult to find good properties at decent prices. If cash-flow is a priority, then rental properties may be your go-to.
For most people, however, putting together enough money for even your own mortgage down payment can be difficult. That is why Real Estate Investment Trusts (REITs) were created. With far lower minimum investment requirements, REITs are index funds or ETFs that can be easily added to your 401k, IRA, or brokerage portfolio to give you some exposure to real estate growth.
Gold and other commodities have historically been good places to park money during high inflation periods as well. Even the most skeptical analyst will admit that there is a high correlation between inflation and gold. Gold was at one point used to back up every US dollar in circulation. While this is no longer the case, there is still a feeling that, if the value of the US dollar is being stressed by inflation, gold in either ETF, futures, or physical forms would be good to have in your portfolio.
Lastly, investors interested in protecting against inflation may want to consider Treasury Inflation-Protected Securities (TIPS). These are bonds, which normally are not a good investment choice in high inflation because fixed-income investments are the most hurt by rising inflation. However, TIPS are issued by the US Treasury, and they are specifically indexed to the current rate of inflation to protect investors against reduced returns.
Inflation may not even be on your radar, but it’s something to be aware of even if you don’t have a finance degree. It can have a dramatic effect on your long-term investment returns, and even a rudimentary portfolio can benefit from some slight changes to help it grow through high inflation periods.