When evaluating the potential return of an investment, don’t forget to add inflation to the equation. Of course, a dollar put in the bank today will have less spending power five years from now, but savvy investors can match, if not outpace, inflation with some clever asset selection. While no investment is guaranteed, here are five types of investments that may help to hedge against inflation.
Life Bridge Capital is a leading real estate syndication company. We offer our investment partners the opportunity to leverage shares of multifamily rental properties into a passive monthly income. Learn More
What is Inflation?
Inflation, which naturally occurs in a market economy, slowly erodes the actual value of assets by lessening their buying power over time. Anyone who grew up reading Little House on the Prairie likely marveled at Pa buying a horse for just a few dollars. The childhood classic is also an early introduction to inflation.
Inflation varies by currency and by year. For example, between 2000 and 2019, the dollar had an average annual inflation rate of 2.1 percent per year. In the United States, inflation is virtually guaranteed. Indeed, many pensions and Social Security have cost-of-living adjustments built in to address this very issue.
Unfortunately, investors have no such automatic safety net in their portfolios. Instead, they must strategize to keep the value of their assets in line or above that of inflation. To do this, turn to assets expected to maintain or increase value over time. In this way, you can hedge against inflation.
1. TIPS
Treasury inflation-protected securities (TIPS) are government-backed bonds that pay interest every six months. The interest rate is tied to the inflation rate, so the rates rise or fall with inflation. Essentially, they are designed not to fall behind during inflationary periods.
Unfortunately, TIPS are not the perfect asset to hedge against inflation. Their interest rate is lower than that of other government securities, and the semi-annual interest payments are considered taxable income even if not withdrawn. One benefit, however, is that they can be purchased in 5-, 10-, and 30-year maturities and redeemed before maturity.
2. Gold
Gold often retains its value against inflation thanks to its tangible nature, even in spiraling economies. However, it does not top the list of assets to hedge against inflation, because it does not produce yields for the holder. Over-relying on gold, especially when rates are high, leads to a loss of possible interest or other income had the funds been invested elsewhere.
Gold investment has moved beyond bars buried in the backyard. Several gold-price-based ETFs now exist to allow for gold investment without managing physical bars.
3. Floating-Rate Bonds
Another bond option to hedge against inflation is a floating-rate bond, also called a floating-rate note. These bonds, which the U.S. government has issued since 2014, feature an interest rate that adjusts periodically. Benchmarks for the rate vary based on the specific bond but are often tied to the Fed funds rate.
4. Stocks
While traditional, fixed-rate bonds offer security in many ways, they do not stand firm against inflation. As a result, many investors prefer to increase their stock-to-bond ratio to 60/40.
Stocks’ short-term ups and downs can be a nail-biter, but they offer a potential long-term solution against inflation. Companies that can raise their prices with inflation are the best bets—as their profits increase, so too should the stock price.
Consider purchasing preferred stocks to retain a high yield but avoid a significant price drop. Utility stocks with their steady dividends may also be a good option.
5. Real Estate
Real estate is the clear winner on this list, offering many ways that investors can use it to build an inflation-ready portfolio. Investment in income-producing property, for instance, avoids the low-or-no-yield conundrum created by some of the options above.
Real estate values tend to rise during inflationary periods, as do rents—but the cost of operating real estate typically remains the same. This makes real estate a good investment for the average homeowner but an even better prospect for an owner or investor of income-producing properties. The good news is that there are several ways to invest in real estate some of which do not require owning or managing any physical property at all:
REITs
Beyond directly purchasing real estate, you can add real estate investments to any portfolio through real estate investment trusts (REITs). REITs are companies that own income-producing real estate, and investors receive dividends for their shares of a REIT. REITs can focus on any of the many segments of the real estate market, including medical buildings, office space, retail space, multifamily housing, and more. You are essentially purchasing stock in the company, which can increase or decrease in value based on the company’s performance, much like traditional stocks.
Real Estate Syndication
Finally, real estate syndications are the perfect opportunity to enjoy high yields and hold an asset that appreciates even during periods of inflation. In a real estate syndication, a group of individual investors contribute capital through an overarching project sponsor to fund a large-scale real estate project, like a multifamily rental property. The project sponsor is the party responsible for all the legwork involved in the project—everything from assessing and purchasing a property to renovations, property management, rent collection and eventual property sale. Meanwhile, individual investors can receive a regular monthly income from rent collection and a potential cut of the profit at time of sale—based on the terms of the deal.
Syndications often report a 15 to 20 percent return for investors. It’s important, however, to pay attention to the holding time for the project if liquidity is a concern. Some syndications plan for a quick termination after only a couple of years, while others can advertise the same projected return extended over 5 to 8 years.
Final Thoughts
Building a portfolio of assets to hedge against inflation essentially protects your hard-won gains. The current high-inflation period serves as a good reminder that the next inflationary period can strike at any time.
Life Bridge Capital is a leading real estate syndication company. We offer our investment partners the opportunity to leverage shares of multifamily rental properties into a passive monthly income. Learn More
