How to Protect Your Investment Portfolio from Inflation

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Like any investor, you hope that your investment portfolio grows over time, generating a solid rate of return each year. But if rapidly rising inflation takes hold, your returns will start looking much less impressive. If you hold mostly short-term investments, such as Guaranteed Investment Certificates (GICs) and treasury bills, your returns could turn negative – not good.

If you sense inflation is imminent, it might be a good time to evaluate your current investment portfolio. Contact your online broker or robo-advisor and start making some strategic, not panicked, adjustments. You can prepare to tackle inflationary pressure. Read on the discover which assets can help protect your investment portfolio from inflation.

Stocks

If you are not already in the stock market, consider this: the stock market is generally regarded as an excellent hedge against inflation. One reason for this is that firms benefit from passing on their increased production costs to customers through higher prices, which helps stave off some of the harmful effects of inflation.

However, it’s vital to remember that not all stocks are created equal. Some perform poorly during inflationary periods while others thrive. When evaluating stocks, your best bet is to focus on companies in sectors that have historically fared well during inflationary times. These are:

• Energy
• Consumers staples
• Industrials
• Basic materials
• Healthcare
• Utilities

Energy, industrials, materials, and consumer staples tend to correlate strongly with inflation, so don’t hesitate to load up on stocks from these sectors. Canada is a leader in energy and mining stocks, and investing in gold is still, well, golden. Healthcare and utilities have a mixed track record as an inflation hedge but still offer adequate protection.

Here’s some other stock investing tips during inflationary times:

• Prioritize value stocks over growth stocks; the latter perform poorly during periods of high inflation, as their earnings are expected farther out in the future. Due to inflation, those earnings will be worth much less when valued today, making them less appealing than value stocks, which offer consistent profits in the present. 
• Avoid too many high-dividend paying stocks: they function very much like fixed-income investments in that their values drop when interest rates rise. The dividends usually don’t keep pace with the inflation rate. They also face increased competition from other assets that offer more attractive yields, further depressing their value.
• Consider allocating some of your money to international equities. Diversify your portfolio by investing in regions where inflation is more subdued.

Real estate

Real estate is another asset class that can shield your investment portfolio from inflation. Those prices tend to appreciate during inflation. If you have tenants, you can easily increase the rental charge to offset rising maintenance, mortgage interest, and property tax costs. 

If tangible real estate isn’t your thing, a practical and convenient way to gain exposure to real estate is through Real Estate Investment Trusts (REIT), which are firms that own and manage real estate assets. REITs trade like stocks and offer a return in the form of capital appreciation and dividends.

However, ensure you stay clear of REITs whose business model consists of investing in mortgages. As fixed-rate instruments, mortgages decline in value when inflation spikes.

Commodities

Investors have routinely turned to commodities when they anticipate inflation. Commodities include tangible items like oil, grains, beef, orange juice, coffee, and natural gas. Modern society depends on commodities for survival; things like energy and food are non-negotiable, so it’s no surprise that they appeal to investors.

If you’re interested in investing in commodities, you can do so through:

• Mutual funds
• Exchange-traded funds (ETF)
• Commodity pools
• Futures trading

Keep in mind that commodities are a volatile asset class and don’t provide any yield, like a bond or dividend-paying stock. They can also remain dormant for many years, even decades, before entering a bull market and generating substantial returns. But with a reasonable allocation to your investment portfolio, they can provide decent protection against inflation. 

Real Return Bonds

As fixed-rate financial instruments, bonds offer poor returns in an inflationary environment, so they should constitute only a tiny portion of your portfolio.

Real return bonds (RRB), however, are a notable exception. Issued by the Canadian federal government, this unique class of bonds offers principal and interest payments indexed to inflation. The interest rate, or coupon, is adjusted semi-annually to account for inflation, as measured by the consumer price index (CPI). Once the bond matures, you receive the face value, which is also adjusted for inflation.

Since RRBs are backed by the federal government, there’s virtually no risk of default, which makes them a safe investment, as well as an excellent inflation hedge. 

However, keep in mind that if the economy shifts to a deflationary trend, the value of the principle will fall, and the interest paid will drop, much like a regular fixed-rate bond.

Precious metals

They encompass a category of commodities that not only have industrial use but have served as forms of money throughout history, which is why they deserve a special mention. Precious metals include gold, silver, platinum, and palladium. 

Gold, the most popular precious metal, is often touted as the ultimate inflation shield and a hedge against domestic currency debasement. More recently, people left gold for cryptocurrency but the success of that move remains to be seen. Gold doesn’t always live up to its reputation as a powerful inflation hedge. But it still has the potential to be effective, as long as it doesn’t comprise a significant chunk of your investment portfolio.

Luckily, gold and other precious metals are more accessible and easier to store than other commodities. You can visit a local dealer and purchase physical bullion bars or coins. Alternatively, you can invest in precious metals through mutual funds, ETFs or mining stocks.

Fight inflation whenever you can

Suppose economic indicators point to a prolonged period of high inflation. In that case, it’s wise to reassess your investment portfolio and diversify accordingly. This reallocation is especially crucial if your investments consist primarily of cash, money market funds, and various fixed-income instruments. 

Explore different ways to reconfigure your portfolio but ensure you don’t lose sight of your long-term investment plan and risk tolerance. Protecting your money from inflation is prudent but remember to always focus on the bigger picture when it comes to your investment goals.