Mastering Inflation: Strategies for Profiting in a Rising Price Environment
In August, the United States Bureau of Labor Statistics (BLS) released its latest Consumer Price Index (CPI) data, which showed consumer prices rising by 3.2% from July 2022 to July 2023. This rise is far from the 8.5% increase for the same period a year earlier.
Except for food and energy, the price hikes are the lowest 12-month jump since the period ending in October 2021. Even with the dip, the diminishing value of dollars leads to sticker shock at the supermarket, and the specter of inflation looms large in the minds of Americans.
However, not everyone is so confident we are out of the woods yet. On August 25, Federal Reserve Chairman Jerome Powell indicated that further interest rate hikes may be possible before the end of the year as the Fed’s 2% inflation target remains elusive. Furthermore, high inflation continues to plague places like the eurozone and the United Kingdom.
Learning how to thrive in these conditions financially is a wise move for anyone, as it’s impossible to be sure how long they will last.
What is less widely understood is that inflation can bring not only costs but opportunities.
Treasury Inflation-Protected Securities (TIPS) are a popular investment hedge against inflation. These are U.S. government bonds that track the movement of inflation and follow changes in the CPI. TIPS pay out fixed-rate interest twice yearly. At the end of their terms, which range from five to 30 years, the investor either receives the adjusted or original principal – the greater of the two.
“TIPS include a compensation mechanism based on the CPI, which is a common measure of inflation,” points out Asher Rogovy, chief investment advisor at Magnifina. “However, inflation is typically measured based on costs for the median lifestyle. A higher cost lifestyle may experience more inflation than is reported in the CPI or other agency statistics.”
I-Bonds, or Series I savings bonds, are a type of U.S. government savings bond designed to protect the holder from inflation. The returns on the bonds are composed of two parts: a fixed-interest-rate component and one that is tied to the CPI. The latter component sees a rate adjustment twice a year. These bonds have the advantage of tax-deferred growth, with the tax payment due at the time of redemption. At the same time, they tend to form only a portion of an investment strategy, as an individual can only purchase $10,000 of them every year.
Buying property is a standard method for dealing with inflation, though it’s important to remember that not all local real estate markets move in tandem. That said, the value of real estate tends to grow along with inflation, and there is the added benefit of leasing it out as rents rise. When the property is purchased with a fixed-rate mortgage, the homeowner can take advantage of the fixed rate as inflation goes on; at the same time, someone who already has a fixed-rate mortgage (or similar debt) gets to pay back their same-sized principal with less valuable money.
For those without the means to buy apartments and houses, investing in the property market through a real estate investment trust (REIT) can be a great way to get exposure to the asset class.
“REITs have historically fared well during inflationary periods since higher interest rates – and hence mortgage rates and rents – are being passed on to investors,” according to Samantha Hawrylack, co-founder of the personal finance blog How to FIRE.
When the prices of goods are rising amid inflation, often the inputs that go into making them are getting more expensive, too. Varied commodities such as oil, soybeans, timber, or cotton may rise in value alongside finished goods, offering investors a means for keeping pace with inflation. However, commodities can be volatile, with their prices impacted by complicated factors such as geopolitics.
“Higher-than-expected inflation is frequently coupled with strong underlying economic development, which stimulates demand for raw resources and puts upward pressure on commodity prices,” says Hawrylack.
She adds, “Since food and energy use account for a substantial portion of the CPI, increased prices in those categories will be reflected in comparable futures contracts. When inflation rises, so do the prices of physical assets and commodities and hard assets such as gold and copper.”
It’s natural to assume that gold is an ideal way to escape inflation, but the history is more complicated. While gold tends to keep pace with inflation over many decades, it often works out differently in the short-term, as myriad factors influence its price. In the high-inflation climate of the mid-to-late 1970s, when inflation reached as high as around 8.8% during some years, gold delivered strong returns of 35%. Nevertheless, in the early 1980s, when inflation was still around 6.6%, gold lost 10% of its value annually.
“Gold, oil, and even soybeans can sometimes feel like they’re playing hide and seek during inflation,” says Andrew Gosselin, senior editor at Money Inc. “But more often than not, they’re going up.”
One investment approach that may outpace inflation is to find stocks with a lower price-to-earnings (P/E) ratio, which suggests they might be undervalued. This strategy, known as value investing, is based on identifying stocks that trade at a discount to their inherent worth. These are often established companies with stable business models, making them less headline-grabbing than growth stocks, which often flourish in low-interest-rate environments.
“When thinking of inflation-resistant investments, stocks might not be the first option that comes to mind,” says John Grace, founder of Investor’s Advantage Corporation. “However, certain companies have business models that align well with inflationary periods.”
“Consider businesses that operate under long-term contracts with built-in price escalations, such as utilities or companies with long-term supply agreements. These companies might have a greater ability to pass on increased costs to their customers, helping them maintain profitability during inflation.”
This article was produced and syndicated by Wealth of Geeks.
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Investing in real estate can diversify your portfolio. But expanding your horizons may add additional costs. If you’re an investor looking to minimize expenses, consider checking out online brokerages. They often offer low investment fees, helping you maximize your profit.
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