The Insider – How to Protect Your Investments Against Inflation
The dark clouds of inflation are bearing down like the herald of a financial storm.
High levels of volatility make it hard to tell how hard and for how long this particular squall is going to last, but it’s time to batten down the hatches.
So how can you protect your portfolio against inflation?
Surviving inflation is about finding assets whose value will rise faster than the inflation rate, to maintain their real return.
It’s a defensive strategy, designed to survive tumultuous times rather than to take big risks for big wins.
Fortunately, it’s easy to identify the assets most likely to protect your investment.
Don’t
These are the ones to avoid during an inflationary period – the assets likely to fall behind in value.
Long-Term Bonds
With their fixed rates of interest, most medium- and long-term bonds are swiftly left behind in an inflationary economy.
Every rise in the inflation rate shaves away at their profitability, until inflation overtakes their interest rates and they become flat-out losses.
We’ll talk about the exceptions in a bit, but in general, getting out of bonds is one way to defend yourself against inflation.
Cash
Money market funds and savings accounts will often provide a lower return than the rate of inflation.
Cold hard cash isn’t a safe bet in an inflationary economy, as shown by the worthless banknotes of countries saddled with hyper-inflation.
Look to take that cash and invest it elsewhere.
Vulnerable Companies
Certain types of companies are particularly vulnerable in an inflationary economy.
If they’re in a sector where they have to compete on prices, then they may struggle to pass on rising costs to consumers.
That means that the company and its shareholders will soak up a lot of financial damage.
Retailers are one of the most vulnerable groups, especially those who don’t deal in premium goods.
High street chains like Tesco and Primark are likely to suffer. Stocks are good, but not these ones.
Do
Having worked out where not to put your money, you need to find somewhere else to commit it. So what are the assets that will rise above the inflationary tide?
Inflation-Protected Bonds
These are the big exception to the no-bonds rule.
Inflation-protected bonds, such as America’s Treasury inflation-protected securities (TIPS), have a value that’s directly linked to the rate of inflation.
They’re guaranteed not to yield a spectacular return when the economy’s flat, but to maintain their output even when things get difficult.
The clue’s there in the name – your investment in these bonds is deliberately protected against inflation.
Stocks in Companies with Pricing Power
While companies who compete on pricing will struggle with inflation, others are less vulnerable.
If a company can control its pricing then it can maintain its profits and emerge stronger from a period of turmoil.
High-end brands are among those likely to survive, as their customers are willing to pay more for what they offer.
Whether it’s prestige tech like Apple or a company specialising in fine wine, these are companies that can keep their prices up.
The other group that will do well are companies whose products always remain in demand.
This includes providers of essential software, specialist engineering firms, and producers of core consumer goods.
Commodities
Commodities and their producers are a safe bet.
The demand for oil and minerals is going to remain high, with prices rising as inflation does.
Investing in the underlying commodity or the company producing it means that you’re investing in something substantial that will retain its value even as cash is left behind.
It’s hard to go wrong by investing in gold.
Real Estate
The limited supply of land provides an underlying value to real estate that makes it a good long-term investment and a safe hedge against inflation.
Property prices have risen steadily in recent years, and that shows no sign of changing.
Rental income means that this is an investment that can pay out now even as it gains value for the future.
Hedge Your Bets
Though you want to pick investments that are safe against inflation, it’s never a good idea to put everything in one basket.
Spread your investments across the inflation-resistant assets and avoid those whose performance is strongly correlated with another class.
That way, if one area falters, you’ll be protected by the rest.
Watch for When to Go Off the Defensive
Defending yourself against inflation isn’t just about riding out the storm – it’s about recognising when clear skies are coming.
If you stick with your defensive investments too long while inflation subsides, then you’ll miss out on the opportunity for profit in other areas.
So keep a careful eye out for a shift in the markets, and be ready to move when they do.
It’s good to protect yourself against the threat of inflation, but don’t spend so long riding out the storm that you miss out on the sunshine.
Paul Connolly
Paul Connolly has been a journalist for more than 20 years, as a reporter and editor for Argus Media, Reuters, The Times, Associated Newspapers and The Guardian. He has covered Islamic Finance for Reuters in the 1990s. Paul has since helped launch three newspapers, as well as reported from Tokyo, Los Angeles and Stockholm.
