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According to the latest figures released by the Bureau of Labor Statistics, inflation remains stubbornly high at 8.3% (August 2022), despite falling slightly from June’s peak of 9.1%.
The Federal Reserve has consistently raised the Fed funds rate to reduce inflation. But so far, there has been no significant improvement in inflation. And there are no guarantees of a turnaround on the horizon.
There are no guarantees that anything will definitely beat inflation. But since high inflation now appears to be a long-term trend, it may be time to take some defensive positions in the best inflation hedges.
The short version
- Inflation has been rising steadily over the past two years, despite the Federal Reserve’s efforts to reduce it by raising interest rates.
- Certain asset classes have proven to be excellent inflation hedges in the past, although there is no guarantee that they will continue to be successful.
- Some of the usual suspects, energy, precious metals and real estate, are on the short list of inflation hedges. Still, precious metals and other asset classes have had disappointing returns so far.
- TIPS can provide a solid inflation-fighting foundation for your portfolio while investing in other asset classes with a history of positive inflation-linked performance.
6 Best Inflation Hedges for 2022
As inflation worries grow, more and more investors are looking for ways to protect their portfolios. While there are many options available, these six inflation covers are some of the best.
1. Treasury Inflation Protected Securities (TIPS)
The US Treasury issues Treasury securities called TIPS. Not only does the US government guarantee the principal amount (if held to maturity), but they also pay interest.
TIPS won’t make you rich during inflation, but they can help you keep up with current prices.
But the secret sauce of TIPS is that the Treasury makes principal additions to the securities based on increases in the Consumer Price Index (CPI). If, for example, CPI rises by 8% in 2022, the government will add 8% to the principal value of the securities you own, plus a small interest rate.
TIPS can be purchased through Treasury Direct in denominations of $100, in five-, 10-, and 30-year terms.
One type of TIPS worth checking out is I-bonds, which currently pay 9.62%. You can buy them in denominations as low as $25 up to a maximum amount of $10,000 per calendar year.
In theory, moving 100% of your portfolio into TIPS will allow you to ride out the current wave of inflation without losing a dime. However, we do not recommend this strategy. Instead, it’s best to maintain a diversified portfolio, even when inflation is lurking.
Diversification is essential, even during inflation, because you never know which investments will have a high return. But TIPS can act as the cornerstone of your portfolio, taking up a large portion of your bond allocation.
Read more >>> How to diversify your investment portfolio
2. Raw materials
Like energy, commodities do well in an inflationary environment. This is also because many are critical to the global economy. And any essential commodity tends to perform well in times of crisis, which is precisely what inflation is.
While oil and gas lead the pack among commodities, other commodities stand out in times of inflation. Examples include metals such as nickel and copper, industrial chemicals, and construction materials. The price of lithium is rising because it is a key component of electric vehicle batteries.
When it comes to commodities, consider investing in a fund rather than individual companies. While a particular company may benefit from a significant rise in the price of a commodity, trying to pick high-performing companies could be a gamble.
For example, until about six months ago, wood was in short supply and the price was rising rapidly. But this situation has since been reversed.
The Materials Select Sector SPDR Fund (XLB) provides exposure to raw materials. The fund invests in companies producing chemicals, construction materials, packaging and packaging, metals and mining, and paper and forest products.
3. Real estate
With the possible exception of precious metals and energy, real estate may be the biggest investment category to perform well during inflation. This has certainly been the case in the last round. The average price of a home sold in the US has risen about 20% annually over the past two years.
If you own a home, you’ve probably already seen a significant increase in value. Most of the country’s major markets, and even many rural areas, saw strong increases.
But even if you don’t own a home, you can invest in real estate through your portfolio. You can add real estate-related stocks or invest in real estate investment trusts (REITs).
Not all REITs have performed well this year, likely due to factors that affected the overall stock market, such as rising interest rates. But some funds have performed positively, such as Sabra Healthcare REIT (SBRA) and VICI Properties Inc. (VICE).
You can also invest in real estate through crowdfunding platforms like Fundrise, Crowdstreet, or X. And Arrived Homes might be a good option if you want to invest in single-family rental properties for as little as $100.
Read more >>> What is a real estate investment fund?
4. Precious metals
Precious metals, especially gold, have been almost synonymous with inflation. Ask almost anyone who answers the question “what is the best investment to hold during inflation?” and more than a fair number will answer gold.
While it’s hard to argue with gold’s past performance in times of inflation, the experience this time around has been much more subdued.
The price of gold responded positively at the height of the Covid crisis, then surged again with the Russian invasion of Ukraine. But shortly after each event, gold retreated. For example, while gold opened 2022 at around $1,825 an ounce, it recently closed at $1,710, down more than 6% year-to-date.
Rising interest rates are partially to blame for weighing down the price of gold. However, if these higher rates do not stop or even slow the rate of inflation, gold’s best days may be ahead.
What seems clear, however, is that gold’s reaction to inflation may be more a matter of history and legend than current reality. Therefore, any investment in gold should represent only a small single-digit percentage of your total portfolio. This would give you upside if the price of gold soars and limit your losses if it continues to languish or even declines further.
You can invest in gold directly by holding gold bullion or bullion coins, but investing in a gold exchange-traded fund (ETF) is cheaper and more convenient. The SPDR Gold Shares ETF (GLD) is one of the most popular. The fund invests directly in gold bullion. But the fund is down about 7% year-to-date and doesn’t pay dividends.
(Author disclosure: I have a small position in the GLD fund.)
Read more >>> How to invest in a gold ETF
This may come as a surprise recommendation to most investors, mainly because the market is not performing well so far in 2022 and certainly has not outpaced inflation.
But when it comes to raising price levels, we have to look at the long term. And in that regard, the stock is performing excellently.
Since the S&P 500 index was developed in 1957, it has produced an average annual return of about 10.7%. Given that inflation averaged around 3% per year during that same period, it’s clear that stocks are one of the best long-term inflation hedges ever.
This is a compelling argument for investing in stocks in all financial and economic environments. While stocks may dip and even fall occasionally, the long-term trend is decidedly positive. And if you are a long-term investor, you can never afford to leave stocks. You can invest easily and affordably by buying any of the many ETFs linked to the S&P 500 index.
You can also invest in inflation-resistant equity funds. For example, the Fidelity Stocks for Inflation ETF (FCPI has “only” lost 9.76% YTD compared to the S&P 500, which is down 17.72% at the time of writing. And over the past 12 months, the FCPI has been virtually flat, while the S&P 500 has declined more than 11% over that period.
The idea of staying invested in stocks does not mean rescuing other inflation-sensitive investments. But stocks should still make up a large percentage of your portfolio, regardless of what happens with inflation.
Read more >>> What makes the stock market go up and down?
6. Stocks and energy funds
If you follow the stock market, you’re no doubt aware that energy outperformed most other sectors for at least the past year. It’s not surprising, given that energy has historically been one of the best inflation hedges. This is likely because, regardless of what happens in the financial world, the global economy still needs energy to keep running.
Major oil stocks have been delivering incredible returns through 2022. For example, Exxon Mobil (XOM) is up 50% through August 31. Chevron (CVX) is up nearly 39%.
If you prefer to avoid picking individual stocks, you can invest in an energy fund. A prominent example is the Energy Select Sector SPDR ETF (XLE). For the price of a single ETF share, you can get a fully diversified portfolio in the energy sector through any major brokerage. Like stocks of major energy companies, the XLE has performed impressively year-to-date, rising more than 40% through August 31.
Energy investments have a bonus in the form of dividends. For example, the XLE has a current dividend yield of 3.48%. Exxon Mobil and Chevron have similar dividend payout rates.
If you are a socially conscious investor, you may have doubts about investing in the oil sector. Fortunately, there are many renewable energy stocks, such as Brookfield Renewables (BEP) and ETFs, such as iShares Global Clean Energy ETF (ICLN).
Related: Oil vs. Renewable Energy Stocks: What Should You Invest in Today?
The bottom line
Investing for inflation is a complicated process. Some investment classes have performed well with inflation in the past, but there is no guarantee that history will repeat itself.
Keeping at least some money in these six top inflation hedges means you’re keeping a diverse portfolio of assets that can grow. After all, an asset class can skyrocket at any moment while a previous high flyer heads in the other direction.