Inflation hasn’t seen highs like this since 2008, and ETF investors should be paying attention. In fact, according to the most recent Consumer Price Index (CPI) inflation report – which measures changes in prices over time – prices over December increased by 7% year over year, which is the highest increase since June 1982.
While increasing labor shortages, global economic issues, and a rising CPI indicate that investors can expect a bit of a bumpy road ahead, many are turning to long-term, supportive strategies that will help them protect their investments.
- What is inflation?
- Here’s what you need to know
- How to protect your portfolio when inflation hits
- S&P 500
- The bottom line
What is inflation?
Inflation refers to price increases over a set period of time. As a consequence of inflation, a given quantity of money will be worth less in a few years than it was previously. This means that finding the correct inflation-hedging methods and investments is critical.
The rate of inflation in a given economy fluctuates based on current circumstances. It is often caused by factors like rising salaries and rapid increases in raw resources, like oil.
Nevertheless, investors can be sure of two things: 1. That inflation is a natural phenomenon and the markets, historically, have always bounced back. And 2. There are numerous ways to protect against inflation. A diligent investor can prepare for inflation by keeping an eye on, and investing in, inflation-hedged asset classes that perform well in the market despite periods of high inflation.
Inflation affects ETFs (exchange-traded funds) in the same way that it affects a broader portfolio. These are securities that follow a variety of different investment strategies, including the close monitoring of indexes, the focus on specific asset classes and industries, and the following of broad markets.
Here’s what you need to know
According to an outlook guide created by iShares (an ETF provider owned by BlackRock), inflation might be long-lasting due to the backdrop of economic growth, increased production costs, and supply chain diversification, among other factors.
While not permanent, it may take months or quarters for the impacts of inflation to subside. It’s affecting all aspects of goods and services, which won’t just vanish overnight without first making its way through the system.
The good news is that we have options available to us to hedge against this inflation.
Inflation in developed economies is likely to stay between 3% and 6% for at least the first couple of months of 2022, indicating that equities continue to be one of the most appealing asset classes, as opposed to bonds.
Lower-risk assets like short-term bonds will return significantly less than inflation in 2022, whereas global, diversified equities remain one of the only asset classes with the capacity to protect capital from the effects of inflation.
How to protect your portfolio when inflation hits
Here are a few of the most effective techniques to hedge against inflation:
According to a Goldman Sachs Investment Ideas 2022 report, equities offer the best opportunity to outperform inflation. Indeed, while past performance is no guarantee of future results, stocks have historically provided higher returns than other asset classes. The report claims that cyclical stocks, such as financials, energy, and resource sectors, are particularly well-suited to benefit from rising prices.
In the long run, stocks do have the biggest upside potential when it comes to inflation. Furthermore, companies that require minimal capital benefit from inflation, while larger companies that are engaged in things like natural resources tend to lose against inflation.
The S&P 500, which is an index of the 500 largest U.S. public firms, currently has a high concentration of capital-light businesses, such as communication services, so they should hypothetically outperform inflation.
Of course, investing in the S&P 500 Index also has its drawbacks. The index tends to favor companies with larger market capitalization, for instance, and does not offer enough exposure to small-cap companies – which have historically earned greater returns in every decade since the 1930s.
Look into the SPDR S&P 500 ETF if you want to invest in the S&P 500 or an ETF that tracks it.
Companies that operate income-producing real estate are known as Real Estate Investment Trusts (REITs). They had a questionable reputation in the 1970s, but that’s not the case today. They’re not only in a stronger position but also offer investors some protection from inflation.
According to the article ‘The REIT Way to Think About Inflation’:
“REITs overall are positioned to benefit from an inflationary environment while providing attractive current income streams – which should grow over time.”
When inflation rises, so do property values and rental revenue. REITs pool real estate investments and distribute dividends to their shareholders.
The value of real estate tends to rise in tandem with the value of consumer items. In their report ‘Three Strategies for Building Inflation-Resilient Portfolios,’ global investment manager Cohen & Steers addresses this brilliantly.
Consider the Vanguard Real Estate ETF (VNQ) if you want broad real estate exposure with a low expense ratio.
Gold has a good reputation for being an inflation hedge. Many view it as a surrogate currency, especially in countries where the national currency is depreciating. Gold is a tangible asset that, by and large, holds its worth.
Gold isn’t a full-proof inflation hedge, however, since central banks tend to raise interest rates during inflation as part of their monetary policy, and non-yielding assets like gold are less valuable than other, higher-yield assets.
However, diversification is essential for a robust portfolio, so you might want to consider investing in a gold ETF like the SPDR Gold Shares ETF (GLD).
Treasury inflation-protected securities (TIPS) are a form of US Treasury bond. They are indexed to inflation specifically to shield investors from the effects of inflation. They pay out at a predetermined rate twice a year, and because their principal value fluctuates with the rate of inflation, the rate of return includes the adjusted principal.
Investing in TIPS ETFs might be wise given the current inflationary environment. Some of the most popular ones are the iShares TIPS Bond ETF TIP, Vanguard Short-Term Inflation-Protected Securities ETF VTIP, the Quadratic Interest Rate Volatility and Inflation Hedge ETF IVOL, and the Schwab U.S. TIPS ETF SCHP.
TIPS ETFs not only fight rising costs, but they also protect income long-term. This is due to the fact that TIPS pay interest on an inflated principal amount (principal rises with inflation).
The bottom line
Any investment can experience losses in the short term. If you can ride out temporary losses and stay invested for the long run, you’ll reap the benefits. Thanks to mean reversion, which outlines how investors respond to crises and sell too fast, we know that if we can resist the temptation of knee-jerk reactions, our investments should continue to recover and grow in value over time.
This long-term investing expertise is epitomized by the buy-and-hold strategy, which consistently outperforms more short-term techniques.
The bottom line is that diversifying your portfolio across various asset types is critical, as it increases your chances of being well-positioned in the best-performing asset classes, irrespective of market conditions.
This approach will allow you to benefit from future growth opportunities while also protecting your money from potential concerns like inflation. An ETF investment strategy is, in our opinion, one of the best ways to do this.
If you’re interested in a low-cost, low-risk way to diversify your portfolio and reduce potential effects of inflation on your investments, open an arty account today and try it for FREE (no credit card needed). arty offers a selection of well-diversified ETF portfolios that you can copy to your own ETF brokerage account. arty controls volatility by using advanced technology and quants (professional quantitative analysts), helping you manage risk while copying winning ETF portfolios.