An economic environment of high inflation can be difficult to navigate for investors - the prices of our day-to-day expenses increase, while the value of our savings decreases at the same time.
In this article, we reveal the worst investments during inflation, and also highlight the types of investments that are regarded as good investments during periods of high inflation.
Please keep in mind that high inflation tends to result in unpredictable market dynamics. There is no foolproof way to grow or even protect your wealth during periods of high inflation. However, there are assets that are generally considered as better options during high inflation and there are also assets which are generally not recommended.
The worst investments during inflation
Cash, fixed-rate bonds and certain types of stocks are generally seen as poor investment choices during high inflation.
1. Cash
Periods of high inflation tend to coincide with higher volatility and uncertainty in the markets. Therefore, it’s not too surprising that some investors start thinking about simply exiting the market and sitting on cash until the situation stabilizes.
While staying in cash can provide a feeling of safety, your purchasing power lowers over time. In addition, by not staying in the market, you can potentially miss some of the market’s most profitable days, which can have a huge impact on your total investment returns.
According to research by JPMorgan, an investment into the S&P 500 between January 1, 2003 and December 30, 2022 which missed the market’s 10 best days would have its annualized return reduced by almost 50%. This further reaffirms the popular saying that time in the market beats timing the market.
To put that into concrete numbers – a $10,000 investment that stayed in the market throughout the entire 20-year period would have grown to $64,844. Meanwhile, a $10,000 investment in the same time period minus the 10 best days would have grown to $29,708.
Even though having too much of your net worth in cash during high inflation is generally seen as a bad choice, it’s crucial to always have enough cash available to have an emergency fund that can cover around 6 months of expenses. In fact, if inflation is very, you might need to increase the size of your emergency fund to account for rising prices.
2. Fixed-rate bonds
Fixed-rate debt securities are usually poor performers in an economic environment with high inflation. If the inflation rate is higher than the interest rate, you’ll be effectively losing money. Keep in mind that the longer-term the fixed-rate debt security is, the more vulnerable it is to inflation.
However, inflation-indexed bonds such as TIPS (Treasury Inflation-Protected Securities) can still be a solid investment during high inflation.
3. Companies with weak pricing power
Companies with weak pricing power are companies that cannot pass on their costs to consumers by rising the prices of their goods and services when their costs increase due to inflation. If they do increase their prices, demand for their products decreases because there are multiple substitutes available on the market. Companies with weak pricing power tend to struggle during periods of high inflation.
What are the best investments during inflation?
So, we’ve covered the assets that investors tend to avoid during periods of high inflation. But what should you invest in to protect your money during rising inflation? Let’s explore some investments that are generally considered as good choices during inflation.
1. TIPS
The acronym “TIPS” refers to Treasury Inflation-Protected Securities. Although the name sounds complicated, the concept of TIPS is straightforward. They are government bonds designed to adjust with inflation levels.
This means if inflation increases, the interest rate you earn on these bonds increases as well. Conversely, if there's deflation, the interest rates decrease. Since the U.S. federal government supports TIPS, they are considered one of the most secure places to put your money.
2. Real estate or REITs
Investing in real estate is one of the traditional approaches to protecting one’s wealth against inflation.
If you want to invest in real estate, you can do so directly or through a REIT (Real Estate Investment Trust). REIT own and operate properties that produce income. Investors in a REIT receive income through dividends. There are also ETFs that invest in a portfolio of different REITs, for example the Vanguard Real Estate ETF (VNQ).
3. Stocks with high pricing power
A company with high pricing power can increase its prices without affecting demand for their products. This holds true for companies that sell unique goods and services that don’t have many substitutes in the market. Companies with high pricing power can afford to increase the prices of their products and services to offset the rising costs caused by inflation.
4. Commodities
The prices of raw materials such as oil and metals tend to increase during periods of heightened inflation, which makes commodities a viable hedge against inflation.
However, we should point out that the commodities market is more volatile than the equities market, which makes it much riskier to participate in.
The cyclical tendencies of the commodity market also makes commodities less suitable for investors that are pursuing a passive, “buy and hold” investment strategy. Commodities traders typically make more short-term investments and utilize futures contracts, which introduce additional complexity.
One commodity that many investors hold over the long term is gold. While gold has a strong reputation as an inflation-resistant store of value, it doesn’t necessarily always protect investors against inflation over the short term as the price of gold can sometimes decrease or stay mostly flat even while inflation is rising. However, on a very long time frame (decades), investing in gold can protect one’s wealth against fiat currency inflation.
Bitcoin is now perceived by some investors as “digital gold” and as a store of value that could potentially provide protection against the inflation of fiat currencies such as the US dollar and the euro. However, Bitcoin has a relatively short track record of just 15 years, which is almost negligible compared to the thousands of years that gold has been used by humans to preserve value.
The bottom line
While there are certainly investments you can make that are more likely to protect your wealth during high inflation, it’s probably not the best idea to overreact and make major changes to your investment plan based on the current inflation rate.
If you have a well thought out long-term passive investment plan, it might be better to just stick to it instead of trying to navigate a high-inflation period in an attempt to preserve as much of your wealth as possible or even turn a profit.
Another important factor to keep in mind is that diversification is key to building a resilient investment portfolio, and this also holds true during inflationary periods. Going all-in on a small number of assets that are considered as good investments during periods of high inflation can quickly backfire.
If you’d like some more investment ideas, make sure to take a look at our list of the best stocks to buy right now.
