With rising inflation, how can you best protect your investments?


The accelerating pace of inflation is one of the main economic trends for 2021.

The Consumer Price Index or CPI, the government’s main indicator of inflation, has hovered around an annual rate of 5% in recent months, well above the 1.4% rate of the last year and the 50-year average of about 3.9%.

Higher inflation rates have the potential to erode the value of investment portfolios, rekindling memories of the 1970s, when big U.S. stocks took it on the chin.

Various investment hedges can help mitigate the damage, but the current inflationary trend might not last that long – and you might already have enough protection. Before taking any drastic measures in inflationary hedges, be aware of the following issues:

Which assets to hedge against inflation?

Various assets can help protect against inflationary spikes. TIPS, or Treasury Inflation Protected Securities, are an obvious example on the bond side. Gold and other tangible assets, including real estate, are also known to be hedges against inflation. Cryptocurrencies could fulfill this role as well.

But during a September 23 webinar on inflation protection hosted by investment researcher Morningstar, panelists found common ground in a less obvious area: the stock market.

“You buy stocks of real companies that make real goods and services,” whose prices tend to rise over time in an inflationary environment, said Catherine LeGraw, asset allocation specialist at the company at GMO investment.

Specifically, stocks of natural resource, commodities and real estate companies can do well during times of inflation. But other companies can too, assuming they can pass price increases on to consumers.

In Morningstar’s discussion, gold received relatively little attention, although Nic Johnson, commodities portfolio manager at PIMCO, described the metal as an asset that can be expected to “keep pace with”. inflation over very long periods ”.

Panelists spent little time on bitcoin and other cryptocurrencies, noting that they had no fundamental value. If you invest in cryptocurrencies, LeGraw said, you had better hope that “the next guy likes them better than you.”

Do you need more protection?

Before making any adjustments, it is worth taking an inventory of what you have in your investment portfolio. Oil and energy stocks, mining companies, real estate companies, and other traditional pillars of inflation are already included in most widely diversified mutual funds and exchange-traded funds, but may not be in the weights that you wish.

Energy stocks, for example, represent less than 3% of the large Standard & Poor’s 500 index. The same is true for materials companies and those engaged in real estate. This contrasts with, say, nearly 28% of index assets held in information technology stocks, 13% in healthcare and almost 12% in consumer discretionary companies.

For more oomph, you might consider adding a bit more to inflation-protected assets such as natural resources or commodities companies, but beware of overdoing it. As a rule of thumb, allocating 10% or 20% specifically in these areas to an already broadly diversified portfolio would likely suffice, Johnson said.

Also consider the inflation protection offered by other assets you may have, such as a house or rental properties. And if you are collecting Social Security retirement benefits, keep in mind that you can expect cost-of-living adjustments, making Social Security a decent hedge against inflation. The Social Security Administration will announce the COLA for 2022 next month.

Where is inflation going?

It is not easy to predict the future direction of inflation. Despite sometimes alarming headlines, it is possible that we have already seen some of the highest numbers of this cycle. Several long-term deflationary forces remain in place, from relatively cheap global trade and imports to the technological revolution, which continues to moderate the costs of computer hardware and other goods and services.

The aging of the US population could also contribute to disinflation, as the elderly tend not to spend as much on new homes, furniture, vehicles, entertainment, etc. (although more in other areas, especially health care).

The three Morningstar panelists were asked about when we are likely to see the CPI numbers drop and stay below 4% on an annual basis. Evan Rudy, portfolio manager at investment firm DWS, said he expects it to happen in the second half of 2022, while Johnson and LeGraw expect it to happen sooner.

The reopening of the economy after the COVID-19 pandemic spurred inflation as consumers began to buy things they had handed over, from vehicles to air travel, and more people are reintegrated into the labor market and were hired.

Supply chains continue to be stretched and this could continue until next year. Prices for some items are already rising at double-digit rates, and retailers and others are warning of shortages for the holiday shopping season.

Yet many of these pressures are unlikely to be permanent. Johnson drew a parallel between recent increases in inflation and the start of a marathon. All the runners initially gather in a small enclosure behind the start line, he noted, but as the race goes on, that congestion decreases as the runners disperse and find their own pace. .

Clues from the past and the future

Past periods of high inflation were not so common, and unique catalysts tended to trigger each of these impacts. In the 1970s, for example, the OPEC oil embargo pushed up energy and transportation costs, and wages rose steadily. There is no such oil embargo currently, and a relative lack of collective bargaining and union strikes these days suggests wage inflation is not likely to become rampant, LeGraw said.

“Do workers collectively have enough power to bring about large wage increases? ” she asked. “Right now, workers don’t have that power. “

Bond investors could get hammered if inflation and inflation expectations continue to rise and interest rates rise, as seems plausible. Bond prices fall and yields tend to rise under such conditions. Yet prices are still high and yields remain near the lowest levels in decades on Treasuries and many other bonds, LeGraw noted, suggesting that investors don’t view them as long-term threats.

Federal policies also play a role. For example, the push towards green energy and more electric vehicle charging stations, as proposed in President Biden’s Build Back Better plan, could initially trigger more inflation if these initiatives are adopted and the construction projects are being carried out, Johnson said. But the push towards renewables could be disinflationary in the long run, he added, if it ultimately means cheaper energy.

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