How to Invest During High Inflation

September 22, 2022

With the annual inflation rate at 8.3% year-on-year, and prices still increasing more dramatically recently than they have in the past 40 years, investors may be wondering if it is wise to invest their money, and if so, where they should put it. Making matters more complex is the fact that the current inflation does not exist in a vacuum - there is a war still going on in Europe that has exacerbated a supply crunch within commodities markets, and the Fed has begun to take the inflationary environment very seriously, with likely more belt-tightening (e.g. higher interest rates, less monetary stimulation) to come.

Here’s what you should be considering whether you’re a novice investor concerned about where you should put your money, or already have an investment portfolio and want to mind your exposures in the wake of a challenging macroeconomic backdrop. 

Key takeaways

  • As an investor, you should understand how inflation —  and the surrounding economic regime —  can impact your investments in order to manage your portfolio. Inflation-linked bonds, commodities, certain equities, and real estate are reasonable candidates to do well in many inflationary environments.
  • Inflationary environments also come and go, and it isn’t easy to time the market. Investors are best-served when they build inflation protection into their portfolios holistically.

5 strategies on how to invest during high inflation

While no investment is without some level of risk, here are five investment strategies that can help you hedge against rising inflation. 

1. Don't sit on excess cash

Everyone should have a reasonable amount of cash available for daily spending needs or emergencies, but squirreling away too much cash can cost you over the long run. Consider the bad news in the current environment: the national average interest rate on savings and checking accounts are nearly 0% according to the FDIC. If the cost of living continues to rise at roughly 8% per year, that means that for every year you hold onto cash you would earn an inflation-adjusted (real) return of negative 8%, and can buy 8% fewer groceries, t-shirts, computers, and the like, for every year you put off consumption. The alternative is to invest, which undoubtedly comes with risk. After all, if you deploy capital into the stock market and it declines, you would have been better off with cash —  even at negative yields. However, a well-constructed portfolio that is cognizant of macroeconomic risks can help alleviate some of this risk over the medium term.

2. Pare down long-term fixed-income investments

Persistently high inflation can eat away at the return of fixed-income assets such as (nominal) bonds — particularly those with a long time until maturity. While the dollar-value of the payments you will receive in the future are indeed fixed, their purchasing power can be a lot less than you might expect when that money is finally returned to you if prices have shot up in the meantime.

An alternative is to invest in TIPS (Treasury Inflation Protected Security), where the interest rate payment and principal rise with inflation. These instruments are not a cure-all, as their inflation-adjusted (real) yield is only currently about 1% annually over the next 10 years and they could lose value in the near-term if the Fed continues to hike interest rates more than anticipated; however, over a longer period of time they provide a lot of benefit that simply leaving money in cash does not.  Better still is to invest in iBonds, which are special instruments provided by the US Treasury that currently guarantee a nearly 10% nominal return right now no matter what happens to inflation going forward; however, most individual investors are only able to allocate $10K into these instruments. This can be part of your strategy, but if you have more than $10K to allocate, it can’t be the whole strategy. 

3. Employ commodity futures

Commodities as an asset class provide another avenue to protect portfolios from inflationary pressures. When an inflationary environment is directly caused by commodity supply shocks, such as we saw in the late 1970s, it is the rise in commodity prices themselves that are trickling through the economy in order to create the overall inflation. Thus, investing directly into commodities provides a valuable source of return for one’s portfolio. Even when inflation has roots in over-stimulative monetary policy or domestic currency weakness, commodities still tend to do well as they provide a safe place to store wealth and often see relatively static demand versus other sectors of the economy (you’re still going to fill up at the pump, even when it hurts your wallet). Of course, a global slowdown in growth can be problematic for commodity prices, which can happen if the Fed hikes rates extremely aggressively and triggers a recession, so there are risks, too. Still, some allocation to categories like energy, precious metals, industrial metals / basic materials, and agricultural products can really help round out a good inflation-hedged portfolio.

The most common way for retail investors to get commodities exposure is through ETFs that hold futures contracts under the hood, but look and trade just like stocks. Consider a “No K-1” ETF to make filing your taxes on these holdings a breeze (but like with all ETFs, be wary of paying too high of an expense ratio for the fund you choose).

4. Be selective about equities

Equities have an interesting relationship with inflation. Depending on the drivers and the type of inflation, many companies’ earning (from which equities derive their fundamental worth) can emerge relatively unscathed if they are able to raise the prices of their goods and services at a rate that is close to the rate at which their input costs (commodities, input goods, and labor) are increasing. However, the conditions that surround the inflationary environment —  be they interest rate hikes and corresponding slow growth, supply chain issues, general lack of confidence, etc. —  can be problematic for both how stocks are valued and how much business they are able to do.

For this reason, it is worth being selective about which stocks you choose in an inflationary environment. While not all equity sectors outperform inflation, historically, energy, consumer staples, and utilities are ones that have. Look for sectors and companies with strong ability to increase their top-line revenue, resilient customer demand, high margins, and near-term cash flows for your best chances of success.

5. Use real estate too, but consider your overall exposure

Real estate is similar to many of the instruments listed above in that it can perform quite well during inflationary periods, while still being subject to some of the same risks such as increasing interest rates and slowing growth. Accordingly, real estate as an asset class absolutely belongs in anyone’s portfolio. Keep in mind, however, that investors who own a home already (or more than one) already likely have plenty of real estate exposure in their overarching “portfolio”, meaning there may be more economic value in diversifying through allocation to other asset classes.

A common way for retail investors to get more real estate exposure is through REIT (real-estate investment trust) ETFs that ultimately derive their value from underlying real estate holdings (careful —  there are also mREITs where the “m” standard for mortgage, which is a different asset class with a different underlying exposure).

A holistic approach

At Global Predictions, we believe in first building a solid diversified base portfolio with a high risk-adjusted expected return and limited downside exposure, then tilting your portfolio to benefit from current macroeconomic trends. We can help you understand your exposure to macroeconomic factors like inflation through our Portfolio Score, and provide unbiased and personalized recommendations that can improve your portfolio based on risks and opportunities that are constantly changing. The strategies listed above are just one piece of the puzzle that we’ve folded into a holistic approach to making you a better investor.

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