Record inflation, which we haven’t seen in forty years, is ravaging Americans’ pocketbooks. And with its firm grip on the stock market, inflation has also had its way with investors’ portfolios. What was once described as a transitory phase now appears to be settling in for a more enduring economic condition that could last many months—well into next year or longer. Fortunately, there are ways investors may be able to fortify their portfolios to mitigate the impact of inflation while seeking positive returns.
Time to Rethink Core Fixed Income Investments
Due to the prospect of higher inflation and rising interest rates, the long bull market in bonds is ending. Core bonds are generating negative returns this year, and it’s only the beginning of what is likely to be a long period of interest rate hikes. In this environment, we don’t believe bonds can provide the kind of ballast to a portfolio as they have for decades. Investors who still want fixed-income exposure may be better off looking to alternatives such as inflation-protected, high-yield, or floating rate bonds. Funds such as these invest in a wide range of fixed income and credit securities with one-year or less durations.
Keep in mind, rates have increased since the publication of this article, but the stipulations and rules for buying them still apply.
Look to Commodities and Real Assets
Commodities and real estate tend to perform well under inflationary conditions because they are natural inflation creators. The value of commodities, such as precious metals, industrial metals, agricultural products, and energy has historically kept pace with inflation. We believe a number of factors are converging to drive commodity prices to their best returns in decades, including underinvestment, pent-up demand following the pandemic, the Ukraine war, and Russian sanctions. While commodities can be very volatile over the long term, we feel all indications are these current forces will continue to drive prices for a while.
We believe the best way for investors to participate in commodities is through ETFs. For example, investors who want to invest in metals can choose from a wide range of fundssome of which track the price of gold bullion, or, for investing in energy, some of which invest in a portfolio of the top energy companies.
Real estate can also be an excellent inflation hedge, with values actually exceeding the rate of inflation over the last five decades. Home values have increased more than 1,608% since 1970 compared to inflation which has increased by 644%. Investors can participate in growing real estate values and income by investing in publicly traded real estate investment trusts (REITs). REITs invest in a diversified portfolio of commercial or multi-family residential properties. Investors can purchase publicly traded REITs as they would an ETF on the stock exchange.
A big caveat for investing in commodity funds or REITs is they can be more complex. It’s critical to know what you are investing in before committing any funds.
Emphasize High-Quality Stocks
The performance of stocks during an inflationary environment tends to be mixed. Generally, capital-intensive companies with high debt and low profit margins tend to struggle when inflation rises. Low capital-intensive companies with low or no debt, higher gross margins, and increasing return on invested capital (ROIC) can perform well during high inflation periods. High-quality companies with strong brands and competitive advantages also have pricing power, which allows them to increase their prices with little or no impact on demand. Therefore, as consumer prices rise, so too do their revenues.
Suppose you expect inflation to continue for some time. In that case, you may want to consider a rotation from economically sensitive companies, such as technology or consumer discretionary companies, and into high-quality companies with the capacity to generate strong cash flow in any environment.
We believe one of the worst moves to make is to abandon this declining market and hide your money in cash. Retreating to savings or money market accounts we feel is the surest way to lose money in an inflationary environment. A CD or money market account earning 0.5% to 2% automatically loses 6% to 7% in value when inflation runs at 8%. We believe it’s essential to have sufficient cash set aside for emergencies (consider maintaining 6 to 12 months of living expenses). Still, beyond that, we feel you should consider staying invested and adjusting your portfolio to counter the impact of inflation.
Protect Your Portfolio with URS Advisory
At URS Advisory, we are always on the lookout for ongoing investment options for our clients—especially when the markets throw us for a loop. This type of monitoring and readjustment is all included in our comprehensive wealth management service. Our high-dividend portfolio, Core Income, contains these inflation-combatting investments.
If you are a retiree or pre-retiree looking for a team of dedicated professionals who will look out for your future financial choices this way, we encourage you to reach out to us. We serve clients throughout Florida. Schedule a call with us today to discuss your possibilities.