Webster defines inflation as a continual rise in the price of goods and services.
It's been many years since the US economy has experienced meaningful inflationary pressure. Considering the record amounts of stimulus and deficit spending that is taking place in 2020, now may be the right time to “inflation-proof” your investments.
What About Interest Rates?
Higher inflation will lead to higher interest rates. Avoiding long-term fixed income investments is a great idea. The higher rates increase, the more bond prices will fall. Plus, longer dated bonds will experience the greatest price adjustment and bear the greatest amount of risk to investors.
So, where does an investor go during an inflationary period? I have listed below a few investment areas to consider, along with a few areas to avoid during times of elevated inflation.
Let's begin with an obvious consideration: commodities. Hard commodities tend to outperform many assets during inflationary times. Think of a hard commodity as anything you can drop on your foot. Precious metals, energy, such as oil or gasoline, and even agriculture are types of commodities. During times of inflation the value of the dollar tends to weaken, which supports higher commodity prices.
TIPS, Bonds, Money Market Funds & Real Estate
Treasury Inflation-Protected Securities
To offset interest rate risk, consider holding TIPS, which are Treasury Inflation-Protected Securities. TIPS are government bonds that adjust for inflation. Their coupon is paid semi- annually based on the current rate of inflation. This flexibility makes them ideal if interest rates move quickly.
Another way to avoid inflation risk is to hold very short-term duration bonds. The US Treasury offers one- to three-month T-bills. As interest rates increase, principle is reinvested at higher rates upon maturity.
Money Market Funds
The same goal can be achieved by investing in money market funds as well. Money market funds are very liquid instruments that invest in short-term maturities. As interest rates increase the underlying securities will reflect higher yields.
Real estate tends to outperform during times of inflation. As prices increase for goods and services, so do rental rates, allowing for real estate to keep pace with inflationary pressure. REITs, Real Estate Investment Trusts, are an efficient way to invest in a space.
What Should I Do With Debt?
Lastly, it's worth mentioning variable rate debt should be replaced with a fixed rate debt. The danger to borrowers who hold variable rate debt during inflationary periods is it may become harder to service elevated interest payments. Debt such as credit cards, lines of credit, including HELOCs (Home Equity Lines of Credit) or variable mortgages are examples of variable rate debt in most cases. Look into consolidating variable debt with fixed rates for the foreseeable future.
The Bottom Line
Most people can’t recall the last time inflation dominated our economy (during the 1970s). Take some preventive steps now to insulate your family’s budget and investments from the associated risks involved.