What Is an Inflation Hedge?
An inflation hedge is an investment that is considered to protect the decreased purchasing power of a currency that results from the loss of its value due to rising prices either macro-economically or due to inflation. It typically involves investing in an asset that is expected to maintain or increase its value over a specified period of time. Alternatively, the hedge could involve taking a higher position in assets, which may decrease in value less rapidly than the value of the currency.
Key Takeaways
- Inflation hedging can be used to offset the anticipated drop in a currency's price.
- Limiting downside risk is a major commonality between institutional investors and currency hedging is a common practice.
How Inflation Hedging Works
Inflation hedging can help protect the value of an investment. Certain investments might seem to provide a decent return, but when inflation is factored in, they can be sold at a loss. For example, if you invest in a stock that gives a 5% return, but inflation is 6%, you are losing that 1%. Assets that are considered an inflation hedge could be self-fulfilling; investors flock to them, which keeps their values high even though the intrinsic value may be much lower.
Gold is widely considered an inflationary hedge because its price in U.S. dollars is variable.
For example, if the dollar loses value from the effects of inflation, gold tends to become more expensive. So an owner of gold is protected (or hedged) against a falling dollar because, as inflation rises and erodes the value of the dollar, the cost of every ounce of gold in dollars will rise as a result. So the investor is compensated for this inflation with more dollars for each ounce of gold.
A Real World Example of Inflation Hedging
Companies sometimes engage in inflation hedging to keep their operating costs low. One of the most famous examples is Delta Air Lines purchasing an oil refinery from ConocoPhillips in 2012to offset the risk of higher jet fuel prices.
To the extent that airlines try to hedge their fuel costs, they typically do so in the crude oil market. Delta felt they could produce jet fuel themselves at a lower cost than buying it on the market and in this way directly hedged against jet fuel price inflation. At the time, Delta estimated that it would reduce its annual fuel expense by $300 million.
Limitations of Inflation Hedging
Inflation hedging has its limits and at times can be volatile. For example, Delta has not consistently made money from its refinery in theyears since it was purchased, limiting the effectiveness of its inflation hedge.
The arguments for and against investing in commodities as an inflation hedge are usually centered around variables such as global population growth, technological innovation, production spikes and outages, emerging market political turmoil, Chinese economic growth, and global infrastructure spending. These continually changing factors play a role in the effectiveness of inflation hedging.
FAQs
An inflation hedge is an investment that is considered to protect the decreased purchasing power of a currency that results from the loss of its value due to rising prices either macro-economically or due to inflation.
What is the inflation hedge strategy? ›
Shifting funds from bonds to stocks, especially preferred shares, is one strategy. Real estate usually performs well in inflationary climates; REITs are the most feasible way to invest. Adding global stocks or bonds to your portfolio also hedges your portfolio against domestic inflationary cycles.
What is the best hedge against inflation? ›
Gold may be the best hedge against inflation and geopolitical risks. Gold emerged as the best commodity to serve as a potential hedge against inflation and geo-political risks.
Is buying a house an inflation hedge? ›
During inflationary periods, real estate prices historically keep up when adjusted for inflation, which may be why real estate is considered an inflation hedge. Rents also tend to rise along with prices when there is high inflation, making investing in rental properties attractive to investors.
Is gold really an inflation hedge? ›
Several factors influence gold prices, the most important being inflation and interest, which are linked. Gold has an inherently limited supply, which makes it an inflation hedge, but despite the commodity's reputation for being a safe-haven investment, gold is not risk-free.
Is the S&P 500 a good hedge against inflation? ›
The most common asset classes for protection against inflation include gold, commodities, a balanced and diversified portfolio with a 60/40 split between stocks and fixed income, real estate investment trusts (REITs), rental income from real estate, the S&P 500, and TIPS.
Where can I put money to hedge against inflation? ›
5 Ways to Hedge Against Inflation
- Move Your Money into a High-Yield Savings Account. If you have your money stashed in a checking or basic savings account—or worse, at home—inflation erodes the value over time. ...
- Buy Treasury Bonds. ...
- Invest in the Stock Market. ...
- Diversify Your Portfolio. ...
- Explore Alternative Investments.
What Are the Worst Things to Invest in During Inflation? Some of the worst investments during high inflation are retail, technology, and durable goods because spending in these areas tends to drop.
What is the safest asset to own? ›
Key Takeaways
- Understanding risk, including the risks involved in investing in the major asset classes, is important research for any investor.
- Generally, CDs, savings accounts, cash, U.S. Savings Bonds and U.S. Treasury bills are the safest options, but they also offer the least in terms of profits.
Overview: Best investments in 2024
- High-yield savings accounts. Overview: A high-yield online savings account pays you interest on your cash balance. ...
- Long-term certificates of deposit. ...
- Long-term corporate bond funds. ...
- Dividend stock funds. ...
- Value stock funds. ...
- Small-cap stock funds. ...
- REIT index funds.
Common anti-inflation assets include gold, commodities, various real estate investments, and TIPS. Many people have looked to gold as an "alternative currency," particularly in countries where the native currency is losing value.
Is silver a good hedge against inflation? ›
"Silver is considered an inflation hedge like gold," says Sean Casterline, a retirement plan consultant at Delta Capital Management. "However, while gold is primarily a store of value and a hedge against inflation and economic uncertainties, silver also has industrial uses.
What is the meaning of hedging in finance? ›
Hedging is a risk management strategy employed to offset losses in investments by taking an opposite position in a related asset. The reduction in risk provided by hedging also typically results in a reduction in potential profits. Hedging requires one to pay money for the protection it provides, known as the premium.
Why is a mortgage a hedge against inflation? ›
Executive Summary. Having a mortgage is often framed as a way for an inflation hedge. As the conventional wisdom goes, with a mortgage your monthly payment is locked in (assuming it's not an Adjustable-Rate Mortgage [ARM]), even if inflation goes up and interest rates rise.
Is inflation good for hedge funds? ›
Market seizures and volatility spikes during regime change can trigger deleveraging, which can pose tail risks to various types of relative value strategies. All in all, rising inflation presents opportunities for hedge funds, but risks abound over the regime transition period.
Why is Bitcoin an inflation hedge? ›
Only 21 million can be mined—a limit set by the currency's founder, who has the pseudonym Satoshi Nakamoto—and there already are about 19.5 million in existence. That constraint, advocates say, means bitcoin is protected from the inflationary pressures that can afflict other currencies.
