How to protect your money from inflation

Some inflation is normal but surprisingly high inflation can be challenging.

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Key takeaways

  • Inflation can be a challenge for investors—especially those with little exposure to stocks and a lot of money in cash or bonds. If you believe future inflation will be an important investment consideration, taking steps to mitigate its impact may make sense.
  • For most investors, it can be a good idea to diversify across several different types of inflation-resistant assets and asset classes.
  • That could include some equity investments like commodity producers and REITs as well as some fixed income investments like Treasury Inflation-Protected Securities (TIPS).
  • It may also help to reduce exposure to investments that are more sensitive to inflation, such as certain Treasury bonds.

Inflation is running hot these days, clocking in at 8.3% year-over-year as of the April reading of the Consumer Price Index (CPI). During times of high inflation expectations, it can be a good idea to double-check how exposed your portfolio is to ongoing inflation pressures.

Why inflation matters to your financial plan

Most people have seen inflation in action: Prices go up over time. That's why most things cost more now than they did when you were younger. Staying ahead of inflation may be an important reason to invest your savings in assets that offer potential growth to counteract its effects.

"Inflation is always important from a financial planning standpoint because you want to think about long-term financial objectives relative to your purchasing power," says Dirk Hofschire, senior vice president of asset allocation research at Fidelity. "The higher inflation may be, the higher your return target will need to be to maintain the purchasing power of your assets."

For instance, if the average annual inflation rate is expected to be 2%, to keep up with inflation an investor would need to build a portfolio with the potential to return at least 2% to maintain their purchasing power.

What you can do

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To stay ahead of inflation, look at your investment mix as a whole and evaluate where you stand. There are no silver bullets—you may need a combination of investments to provide a potential return that can keep up with the effects of rising prices. And some investments may be better for the job than others.

"Stocks tend to keep up with inflation better over time than bonds because their earnings can adjust upward, due to stronger company pricing power," Hofschire says. "So if you're a young investor, 40 years from retirement, with a large allocation to stocks, it may not be necessary to add much additional inflation protection."

But retirees with a very conservative investment mix may be exposed to higher inflation risk. By adding inflation-resistant investments to your portfolio and diversifying across asset classes, you may be able to reduce this risk. It’s not all bad news though—people who are retired may already benefit from inflation-adjusted income through Social Security, defined benefit pensions, or annuities with cost-of-living adjustments.

Read Viewpoints on 5 ways to help protect retirement income

"And if inflation is more of a US issue than one for other countries, the dollar may weaken, so holding non-US currencies and assets may help diversify," Hofschire adds.

Since inflation erodes the purchasing power of money, if inflation was worse in the US compared to other countries, a dollar wouldn’t go as far as other, less affected, currencies. One way to get indirect exposure to non-US currencies is by investing in non-US companies.

That’s not what’s happening now, Hofschire notes. Inflation pressures are global and high commodity prices and supply chain disruptions have affected everyone. It is something to be aware of though and international diversification is a good idea.

Equity investments to consider

  • Commodities and commodity-producer equities (energy, materials, etc.)
  • Value stocks, which tend to have more of this exposure, according to Hofschire
  • US and international stocks
  • Real estate investment trusts (REITs)

Inflation-resistant fixed income investments to consider

  • Treasury Inflation-Protected Securities (TIPS)
  • Shorter duration bonds
  • High-yield bonds

Other investments to consider

  • Gold
  • Real estate

How Fidelity's Strategic Advisers group is managing client accounts

Fidelity's Strategic Advisers Inc. manages client portfolios. One of their institutional portfolio managers, Naveen Malwal, reports that diversified client accounts have been repositioned numerous times over the past year in an effort to reduce the level of risk and provide some protection from inflation.

"One of the key investment decisions we made earlier this was year was to increase exposure to commodities within well-diversified client accounts," Malwal says. "That’s because historically, commodities have provided strong protection from inflation for investors."

"We also have exposure to real estate stocks, TIPS, and high-yield bonds in client accounts," he says. "Those investments have also generally performed well for investors when inflation has been higher than average."

Surprisingly high inflation can be a challenge

Some inflation is normal—and even good because it means the economy is growing. But inflation doesn't always behave the way it's expected to. If it's higher than expected or stays at an elevated level for a longer time than markets expect, managing investments can get tricky.

"Surprisingly high inflation can be a challenge for investment portfolios for 2 reasons: First, both bonds and stocks typically perform less well in a more inflationary environment. Second, stock-bond correlations tend to rise when inflation is higher. So bonds may provide less diversification benefits in that kind of environment," Hofschire says.

Navigating inflationary periods can be challenging

What makes inflation a challenge is that investments that stand up well during periods of sustained high inflation may not perform well most of the time. For instance, gold has historically been an effective hedge against extreme inflation as you can see in the chart, Best investment returns over time.

But while gold has historically kept up with inflation, it doesn't offer compounding returns and the price can be relatively flat for long stretches of time.

"I believe historical evidence shows yet again why equities should form the foundation of any investment strategy. Equities offer growth potential, a store of value, and some measure of protection against inflation, not to mention the magic of compounding. Bonds have proven valuable as well, historically returning around 5% a year," says Jurrien Timmer, director of global macro at Fidelity.

The chart also includes a traditional 60% stock/40% bond portfolio as well as a 60% stock/30% bond/10% gold mix. During the 1970s, a 60/30/10 portfolio generated only an extra 20 basis points of compound annual growth rate (CAGR) versus a standard 60/40. "The difference isn’t large, indicating that gold tranche, at 10%, was not sufficient to move the needle," Timmer says.

"One of the lessons here may be that, during normal times, investors may want to limit that portion of their portfolios dedicated to inflation hedges (like gold), given the high opportunity cost of reduced investment in assets that compound over time. But when conditions go extreme—meaning high inflation or hyperinflation—no matter how big one's hedge is, it will seem not nearly enough, at least in my experience," Timmer says.

Be proactive about inflation

Like sudden market drops and economic recessions, inflation is another risk that investors need to plan for. Creating an investment mix that considers your time horizon for investing, risk tolerance, and financial situation may help you weather the storms that may crop up along the way. Though you may not be able to avoid inflation completely, taking steps to protect your portfolio from it may mitigate some of its impact and help keep you on track to your goals.

Next steps to consider

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