Interest rates are on the rise. You might be asking yourself what to do with your investments right now. How can you hedge against inflation? Good question. But please realize that some “cures” to this problem are worse than the disease itself. What’s a smart investor to do? In my experience, there are 5 important steps you can and should take:
1. Understand What You Are Dealing With
Inflation, even tame inflation is not something to be trifled with. Consider that the long-term average inflation is 3.5%. Over the last 20 years it’s averaged ”only” 2.5% . But even at that “modest” rate of inflation the value of your dollar will shrivel 28% in 10 short years. Bottom line? Inflation is dangerous – especially to people on a fixed income (like retirees). Now might be a great time to reposition your portfolio to offset future increases in your cost of living.
2. Know how bonds work.
When people invest for income they often look to bonds. But right now that is just about the worst investment you can make. That’s because the price moves inversely with interest rates. In other words, as interest rates rise, the value of the bond declines. If you hold on to the bond until it matures you will get back what you invested (assuming the entity that borrowed your money is still around ). But you still lose purchasing power. Remember, even if inflation stays at this low rate of 2.5% the value of your income and principal will shrink by 28% in 10 years.
Some investors try inflation adjusted bonds – otherwise known as TIPS. These bonds offer a tiny hedge but not much. They provide a fixed interest rate but a variable principal amount. Here’s what that means. Your principal rises as CPI increases. And because you earn interest based on the value of your principal, your income will rise if inflation heats up.
The only problem with TIPS right now is that the rates are very low. A 10 year bond is yielding less than 2%. Bottom line? The TIPS might be a better choice than non-adjusted treasuries – but not by much.
3. Forget Commodities
Gold, silver, corn, oil, platinum. These are all commodities and if inflation rises the prices of these commodioties will also rise. But I don’t like these kinds of investments for most people. Here’s why:
- They don’t create income
- They are highly volatile.
- You really have to be an expert to make money.
Sure if inflation heats up commodity prices might rise. But not always. Prices can drop – sometimes precipitously. Anyway, most people who are concerned about inflation are worried about income. And commodities don’t provide that. They are for people who are willing to speculate. If you are not willing to throw the dice, don’t invest in commodities friend.
4. Real Estate
I believe that real estate can be a wonderful way to hedge against inflation right now. Prices are still on the rise (no guarantee of the future of course) for the right kind of real estate in the right markets. Also, interest rates are low and there is a lot of demand for residential rentals right now. I am not a fan of buying REITs which are publicly traded real estate investments. But if you have enough scratch, I suggest you consider real estate as a great way to potentially beat inflation.
I have long been a fan of using equity investments to slay the inflation dragon. Sure prices are volatile and many good stocks don’t pay a dividend. Who cares? There are other ways to generate income from your equity portfolio.
As you can see, you still have a number of great tools at your disposal if you want to create income in an inflationary situation. Just keep in mind that the typical solution for those who want income (bonds) is probably the worst investment to make in a period of rising inflation.
Are you changing your portfolio as a result of rising interest rates? How?