Q: How can I protect my investment portfolio and savings from a rise in inflation?
A: Inflation is discussed a lot in today’s environment. Whether it be an impact on your grocery bill, filling up your car, or your daily Starbucks run, many are wondering how they can hedge their investment portfolio and other savings against a rise in inflation.
Here are some short-term hedges that can be used to help protect your portfolio and savings from rising inflation:
- Treasury Inflation-Protected Securities (TIPS): When purchasing fixed-income securities, investors face purchasing power, or inflation, risk. As you can imagine, inflation reduces the purchasing power of the dollars that you receive from security. In an effort to protect investors from the impact of inflation, the U.S government first introduced TIPS in 1997. TIPS pays a fixed rate of interest, but the principal amount of the bond is adjusted by changes in the Consumer Price Index (CPI) every six months. As inflation increases, the interest paid on the bond increases, and if deflation occurs, the interest on the bond decreases.
- Series I Savings Bonds: I-bonds are another type of fixed income security that is issued by the U.S. government. The “I” in I-bonds stands for inflation, which means that the interest rate is a component of both a fixed interest rate and the CPI that will adjust up or down every 6-months based on inflation data. If inflation rises, the interest rate of the bond goes up. If inflation falls, so will the interest rate.
- Stocks: Inflation can actually be good for stocks, up to a certain point. Inflation typically begins to increase when the economy is expanding. These periods of economic expansion are often associated with rising employment, leading to increased consumer spending, which translates into higher corporate profits. Higher corporate profits will most likely result in a higher demand for the company’s stock, which will translate into rising stock prices.
- Commodities: Think of a commodity (i.e., gold, oil, copper, lumber, etc.) as the inputs needed to create a particular good or service. Unlike bonds, and to some extent stocks, commodities tend to increase in value during inflationary periods. As the demand for goods and services increases, the price of those goods will increase, which will increase the prices of the commodities it takes to produce those goods and services.