Inflation is not merely the rate of change in an arbitrary index; it significantly reduces disposable incomes and diminishes the value of savings. Therefore, It Is Important to hedge our funds against Inflation by diversifying our portfolios and choosing inflation-protected securities. Gold Is considered as a smart hedge during uncertain times; but rather It is not a true perfect hedge against inflation. The opportunity cost of holding gold is high because governments tend to adopt tightening monetary policy to combat high Inflationary pressures (aka Increasing Interest rate) and since gold as a physical asset does not yield any returns, an Investor would be forgoing another asset that could yield a higher return.
There are several investments that might possibly protect your savings. Treasury Inflation-Protected Securities (TIPS), Real estate investment trusts (REITs), commodities, and stocks of companies that benefit from Inflation.
Starting with the TIPS, unlike other Treasury securities which have a fixed principal, the principle of a TIPS can rise or fall over the duration. If the principal is greater than the original amount when the TIPS matures, you will receive the difference. You get the original amount if the principal is equal to or less than the initial amount; therefore, you will never receive an amount less than the original amount you paid. TIPS pay a fixed half-annual interest rate until maturity. The amount of interest paid changes because interest is paid on the modified principal and based on the inflation rate. TIPS can be held until maturity or sold before maturity. It has 3 maturity periods: 5-, 10-, and 30-years maturities. There are TIPS ETFs such as the iShares TIPS Bond ETF (TIP), the Schwab US TIPS ETF (SCHP), and the FlexShares iBoxx 3-Year Target Duration TIPS Index ETF (TDTT) that are all available for trading for CFI clients.
TIPS may appear to be an appealing investment, but there are a few concerns that investors should be aware of. The principal amount may decrease if there is deflation or if the Consumer Price Index (CPI) falls. If the face value of the bond rises, you will also have to pay more tax (and this could nullify any benefit you may receive from investing in TIPS). Finally, TIPS are susceptible to changes in current interest rates, so you may lose money if you sell your investment before maturity.
Another option is Real estate investment trusts (REITs). It consists of a pool of securities that operate Income-producing real estate or related assets and pay dividends to Its shareholders. REITs typically focus on a certain area of real estate. Diversified and specialty REITs. On the other hand, they could include different sectors in their portfolios, such as a REIT that owns both office and retail assets. There are different types of REITs; Equity, mortgage, and hybrid REITs. Around 145 million U.S. investors own REITs either directly or through their retirement savings and other investment funds, based on Nareit, a Washington, D.C.-based REIT research firm. As Inflation hikes, prices of properties Increase; thus, yielding higher returns.
Even though REITs are considered high-liquid assets, transparent, and offer attractive risk-adjusted returns, their dividends are subject to high Income-taxes, they have low growth, and have high management and transaction fees. If Investors seek a lower expense ratio, they can go for a REIT ETF such as the Vanguard Real Estate ETF (VNQ).
Commodity prices, on the other hand, are Indicators of high Inflation. Due to their intrinsic value, commodities are thought of as a hedge against inflation and typically perform well when consumer goods prices are rising. In contrast, equities typically perform poorly when high inflation causes an increase in interest rates, which tends to reduce the value of future cash flows for businesses due to the effects of inflation. According to Vanguard research, over the past ten years, commodities increased by 7% to 9% for every 1% of unexpected inflation (the difference between anticipated and realized inflation) that the economy experienced. Companies that work in energy profited massively during this year with the Increase In commodity prices. On a global basis, realized crude oil prices increased 67.8% y-o-y in Q2 to $107.72 per barrel. Additionally, the price of realized natural gas liquids increased by 67.8% y-o-y to reach $42.04/ barrel globally. Prices for natural gas climbed 114.9% from the same quarter last year to $5.03 per thousand cubic feet globally. For example, Occidental Petroleum Corporation (OXY)'s net Income Increased by more than 3000 % y-o-y from 103m to 3.955B during Q2'22.
The content published above has been prepared by CFI for informational purposes only and should not be considered as investment advice. Any view expressed does not constitute a personal recommendation or solicitation to buy or sell. The information provided does not have regard to the specific investment objectives, financial situation, and needs of any specific person who may receive it and is not held out as independent investment research and may have been acted upon by persons connected with CFI. Market data is derived from independent sources believed to be reliable, however, CFI makes no guarantee of its accuracy or completeness, and accepts no responsibility for any consequence of its use by recipients.