Inflation Could Give Your Portfolio A Nasty Knock. Here Are Five Ways To Protect Yourself.

Inflation Could Give Your Portfolio A Nasty Knock. Here Are Five Ways To Protect Yourself.
Reda Farran, CFA

almost 3 years ago4 mins

No one knows if the recent uptick in inflation expectations is a sign of things to come. But with investor jitters already taking a toll on traditional portfolios, you’d be wise to find new ways to profit from this new inflationary world – just in case.

1. Ditch growth, search for value

For starters, you might want to move some of your stock holdings from growth stocks to value.

See, expensive-looking growth stocks – like those of tech companies – are hit disproportionately hard by rising inflation expectations. That’s because if prices rise too far, too fast, the US central bank will be forced to slow things down by raising interest rates. And since growth stocks’ business models typically trade profitability today for the promise of higher earnings tomorrow, higher interest rates reduce the present-day value of those future earnings.

Value stocks, on the other hand, hold up well in a rising inflation environment – especially if inflation is rising due to strong economic growth, like it is today. When overall economic growth rises, growth stocks become comparatively less attractive. Investors, then, start to shift their attention to cheaper value stocks: that is, companies underappreciated by the market, which could deliver decent earnings if the economy keeps improving.

💰 Where to invest: The Vanguard Value ETF (ticker: VTV) is a cheap, well-diversified ETF that’ll give you long-term exposure to value stocks.

2. Look for under-the-radar bonds

Traditional bonds tend to perform quite poorly in a rising inflation environment, since their fixed, future payments are worth less if the prices of goods and services are ticking higher. But there is a special subset of bonds – mostly issued by the US and the UK governments – called inflation-linked bonds, whose principal and interest payments rise and fall with the rate of inflation.

💰 Where to invest: The iShares TIPS Bond ETF (ticker: TIP) gives you exposure to inflation-linked bonds issued by the US government. In the chart below, you can see that TIP has outperformed IEF – an ETF that tracks traditional government bonds – by almost 12% over the past year.

One-year performance of inflation-linked bonds (TIP) versus traditional government bonds (IEF). Source: Koyfin
One-year performance of inflation-linked bonds (TIP) versus traditional government bonds (IEF). Source: Koyfin

3. Throw in some gold and other commodities

Gold and other commodities have an intrinsic value that’s underpinned by their limited supply, which means they become more popular when inflation is rising and eroding the extrinsic value of money. In other words, gold and other commodities have historically performed well during periods of rising inflation. And even better, their prices are also getting another boost from potentially huge infrastructure plans in the US and China.

💰 Where to invest: The SPDR Gold Trust (ticker: GLD) is one of the biggest gold ETFs in the world, and the Invesco DB Commodity Index Tracking Fund (ticker: DBC) – which is up by around 65% over the past year – gives you easy exposure to a wide basket of commodities.

4. Build some real estate into your portfolio

Investing directly in real estate requires a lot of capital, sure, but real estate investment trusts (REITs) – that is, shares in companies that own and operate income-producing real estate – offer a nice alternative.

By law, 90% of a REIT's profits have to be distributed as dividends to its shareholders. That’s why the bulk of its value to investors comes from its income potential, as opposed to the price appreciation of its underlying properties. That’s good to know since that price appreciation would slow down if the US central bank does decide to increase interest rates.

Real estate provides natural protection against inflation, both because prices of physical assets tend to increase with inflation, and because property owners usually increase their rents to offset price rises. In some cases, such as commercial real estate, many rental contracts have mechanisms that automatically adjust the rent to the level of inflation.

💰 Where to invest: The Vanguard Real Estate Index Fund (ticker: VNQ) offers broad exposure to US REITs and, by extension, exposure to lots of different kinds of real estate, from residential to commercial.

5. Did someone say crypto?

Consider this more of a wildcard option. Plenty of investors see crypto as a hedge against the unintended consequences of countries’ current economic stimulus policies – including high inflation, currency devaluation, and negative interest rates. So if investors lose trust in traditional government-issued currencies whose value is being eroded by inflation, they might be even more tempted to invest in cryptocurrencies such as bitcoin – which has a finite supply and can’t be printed by governments.

💰 Where to invest: You could pick and choose crypto, but perhaps a more sensible strategy is to diversify across the biggest ones via the Bitwise 10 Crypto Index Fund (ticker: BITW), which tracks an index comprised of the 10 most highly valued cryptocurrencies.

Key takeaways

  • Fears of red-hot inflation are starting to wreak some damage on traditional stock and bond portfolios.
  • So you might want to shift your stock allocations from growth to value, and bond allocations from traditional to inflation-linked bonds.
  • You might also want to think about adding gold, commodities, real estate, and crypto to your portfolio.


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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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