Best Investments For Inflation: What To Buy In A High CPI Environment

Real Estate

Is inflation scrambling your nest egg? If so, you’re not alone. The market’s been weak since inflation kicked into high gear in the second half of 2021. More than a year later, we’re still struggling with extreme price increases and reduced balances in our brokerage accounts and 401(k)s.

Fortunately, there’s still time to add inflation-resistant investments to your portfolio. A good mix of asset classes can smooth out your volatility, both for the remainder of 2023 and well into the future. Read on to learn what causes inflation and which investments perform best when prices are on the rise.

What Causes Inflation

Inflation is brought on by a mismatch between demand and supply. That mismatch can originate on the demand side or the supply side.

Demand-Pull Inflation

Demand-pull inflation occurs when consumers want more stuff than producers can supply. You see this happen periodically in the real estate market. Property prices rise—sometimes in a crazy way—when there are more homebuyers than homes available. Demand-pull inflation is a similar dynamic, just spread across the entire economy.

The underlying causes of demand-pull inflation include broad changes in consumer preferences, stimulus programs that put more money in people’s pockets or low interest rates that allow for cheap borrowing.

Cost-Push Inflation

Cost-push inflation begins with supply shortages that occur while demand remains strong. Supply shortages have their own causal factors. Most of them involve higher costs on raw materials and labor. Producers then pass these costs onto consumers in the form of higher retail prices.

Pandemic-Related Inflationary Factors

The great inflation spike we’re experiencing now has its roots in both demand and supply. The factors in play include:

  • Pent-up spending demand after 2020 pandemic lockdowns
  • Pandemic-related stimulus payments
  • Ongoing supply chain disruptions due to the pandemic
  • The Great Resignation and its effect on the labor supply and worker salaries

Sadly, inflation is not easily or quickly resolved. The price increases will continue until demand cools to meet the supply or until supply increases to meet the demand. Know, too, that prices won’t typically decline when the inflationary environment is over—they just stop rising as quickly.

With inflation at a 40-year high running at more than 6.4%, dividend stocks offer one of the best ways to beat inflation and generate a dependable income stream. Download “Five Dividend Stocks To Beat Inflation,” a special report from Forbes’ dividend expert, John Dobosz.

Best Investments For Inflationary Times

Some assets outperform under inflationary pressure, others hold their own and still others decline. The challenge you face is balancing these different behaviors for good performance no matter what’s happening with inflation. Why? Because you can’t consistently predict when inflation trends will change.

For that reason, you don’t want to go all-in on inflation hedges. You’ll regret it if inflation moderates unexpectedly.

Keep that in mind as you review the six investments below. All have a role to play in an inflation-resistant portfolio, but some—like gold—are better in smaller doses.

1. Stocks

As Bob Sullivan of Forbes Advisor reports, the long-term average annual return of the S&P 500 is about 10%. According to Consumer Price Index (CPI) data from the United States Bureau of Labor Statistics, the long-term average annual inflation rate is 3.5%. Those numbers tell the story. Over the long haul, stocks handily beat inflation.

What does this mean for your investment portfolio? A steady, long-term position in stocks should protect your wealth from rising prices.

Admittedly, this is a tough truth to accept. After all, the stock market typically struggles while inflation is high. Just remember that these cycles are temporary. Eventually, inflation will level off and the stock market will recover. Staying invested is the best way to participate in the growth that follows.

2. Dividend Aristocrats

Dividend Aristocrats are S&P 500 companies that have raised their dividends for 25 or more consecutive years. Examples include home improvement retailer Lowe’s (LOW) and payroll processor Automatic Data Processing (ADP). Both companies have pushed through annual dividend increases for more than 45 years running.

A reliable source of rising income can offset some of the higher living costs you experience when inflation spikes. Long term, you also benefit from share price appreciation on these positions.

Know that Lowe’s or any fellow aristocrat can change its dividend policy. Dividend Aristocrats don’t often skip increases or cut their dividends, but it does happen.

3. Real Estate

Property values and rents typically rise with inflation. So, your real estate holdings should increase in value and income potential as prices go up.

You can buy real property to get those benefits, but you may not want to. Today’s high mortgage rates are an obstacle. In these uncertain economic times, you may also be reluctant to take on an expensive and illiquid asset.

Alternatively, you could invest in real estate exchange-traded funds or real estate investment trusts (REITs). Examples include Vanguard Real Estate ETF (VNQ) and Realty Income (O). Both provide exposure to real estate, but with more diversification, lower commitment and a smaller cash outlay than physical property.

4. TIPS

Treasury inflation-protected securities (TIPS) are U.S. Treasury bonds that are indexed to inflation. Their value goes up whenever the CPI rises. Even better, TIPS’ interest payments also increase when inflation spikes. This is because those interest payments are calculated by applying the bond’s coupon rate to the principal value.

Unfortunately, TIPS are best purchased before inflation kicks in. That’s when you maximize the value of those inflation-driven principal adjustments. If you don’t have a functional crystal ball on hand, you might choose to hold a small TIPS position consistently—so at least you’re prepared for the next inflationary cycle.

With inflation at a 40-year high running at more than 6.4%, dividend stocks offer one of the best ways to beat inflation and generate a dependable income stream. Download “Five Dividend Stocks To Beat Inflation,” a special report from Forbes’ dividend expert, John Dobosz.

5. Commodities

Commodities are raw materials like corn, wheat, energy, precious metals and livestock. Research from Vanguard concludes that commodities can appreciate 7% to 9% for every 1% of unexpected inflation in the U.S. economy. No doubt that is the type of return you’d want to see from your inflation hedge.

You can invest in commodities via futures contracts, but ETFs are a simpler option. You can find commodities ETFs that specialize in one type of commodity, like oil or agriculture. Or, you can invest in a fund with a broader strategy. iShares S&P GSCI Commodity-Indexed Trust (GSG), for example, provides exposure to energy, industrial and precious metals, agricultural and livestock.

6. Gold

Gold is a type of commodity, but it deserves its own explanation. Many investors tout gold as a solid inflation hedge. Unfortunately, its performance in this regard has been inconsistent. Gold did very well in the late 1970s when inflation shot up into the double digits. But in other inflationary periods, gold has lost value. This includes the months between March and November 2022, when inflation averaged more than 8%.

Still, gold has appeal as an alternative asset. It tends to appreciate in very uncertain economic times. You might consider it a hedge against economic disaster rather than a pure inflation play.

You can buy physical gold, but it’s easier and safer to hold a gold ETF. SPDR Gold Trust (GLD) is a popular choice that is backed by real gold.

How Different Asset Classes Perform During High CPI Environments

Knowing generally how the various asset classes respond to rising prices can improve your decision-making. Read on for the highlights.

Stocks: High inflation raises costs for businesses and can lower demand, depending on the product. Margins and earnings can decline as a result. Elevated levels of inflation also affect investor sentiment. Generally, when investors are nervous, with or without earnings declines, stock prices will fall, except when negative sentiment turns extreme, which tends to precede stock market gains.

Fixed Income: Rising interest rates push bond prices lower. Longer maturities will be more affected than shorter ones, which can reprice faster to match market conditions.

Real Estate: As noted, real estate values and rents tend to rise with inflation. This relationship is more direct with physical property vs. securities that are backed by real estate. Securities, ETFs and REITs included, are additionally influenced by investor sentiment and other financial market factors.

Commodities: Commodities are one of the more consistent and effective inflation hedges. If higher commodity prices aren’t the root cause of higher inflation, they will be an outcome.

Cash: Inflation lowers the purchasing power of cash. The cash news isn’t all bad, however. When inflation spikes, the Federal Reserve responds by raising interest rates. Those higher rates flow through to yields on cash deposits. So, yes, the cash in your wallet buys less. But the cash in your bank will earn more—particularly if you are holding that cash in a high-yield savings account.

Think Long Term And Prepare For The Short Term

Here’s the bottom line: Stocks perform poorly in the throes of extreme price increases, but stocks also outpace inflation over the long term. As tough as the stock market seems right now, you’re smart to stay in it. It’s counterproductive not to.

Fortunately, exposure to other asset classes like real estate, TIPS and commodities can smooth out your overall volatility in these tough times. Add those to your portfolio in small quantities—and then hang on until the next bull market. That’s the simplest way to restore your nest egg and get back to growth.

Five Top Dividend Stocks to Beat Inflation

Many investors may not realize that since 1930, dividends have provided 40% of the stock markets total returns. And what is even lesser known is its outsized impact is even greater during inflationary years, an impressive 54% of shareholder gains. If you’re looking to add high quality dividend stocks to hedge against inflation, Forbes’ investment team has found 5 companies with strong fundamentals to keep growing when prices are surging. Download the report here.

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