In October this year, the U.S. 12-month Consumer Price Index (CPI), a gauge of inflation, reached the highest level since 1990, registering a 6.2 percent growth year on year. Moreover, the Federal Reserve sees inflation continuing well into next year. Some experts believe high inflation levels will remain for a few years. In such a scenario, protecting your finances against inflation is critical to maintain its value and avoiding your portfolio from declining in the coming years. Here are four ways you can protect assets from inflation.
Limited cash and fixed income assets
In an inflationary economy, holding too much cash is a strict no-no since inflation reduces the value of cash. Thus, to retain the value of your total assets, avoid putting cash in the bank or in bonds with low yields. You must only hold cash necessary to meet financial obligations and emergencies. If the Federal Reserve raises rates, fixed income assets like bonds, certificates of deposit, fixed annuities etc. will become less attractive. The only exception would be bonds that give yields of around three to four percent a year.
Invest in stocks
Focus on building a portfolio of stocks that benefit from high inflation or interest rates. This includes companies operating in sectors like energy, utility, banking, consumer staples, and so on. During inflationary periods, the Fed might decide to raise interest rates, which would be beneficial to banks. In contrast, companies involved in the housing and automotive sectors can get hit hard by the combination of inflation and higher interest rates.
Be wary of expensively priced stocks as they can be more at risk of a downward plunge. Go for stocks with reasonable valuation. According to financial advisor Mitchell Goldberg, companies that can generate consistent cash flow, revenues, earnings, and dividends for the long term are a good option for your portfolio during periods of inflation.
“You want to own companies with higher fixed costs, higher pricing power [and] lower labor exposure… You don’t want to own companies that are priced for perfection,” Jenny Harrington, CEO and portfolio manager at Gilman Hill Asset Management in New Canaan, told CNBC.
Invest in commodities
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Gold is a definite must-have hedge against inflation. However, gold isn’t the only commodity to keep in your portfolio. Commodities like oil, corn, and natural gas are all good hedges against inflation.
According to a report by Vanguard, commodity inflation beta has fluctuated between seven and nine for the last decade. This means that a one percent rise in inflation will translate into a seven to nine percent increase in the prices of commodities. Surprisingly, the stock index was found to be inconsistent in its performance as an inflationary hedge when compared to commodities.
“Inflation-protected bonds are by their nature intended to hedge against inflation. But with a far lower beta to unexpected inflation (around 1), they would require a significantly higher portfolio allocation to achieve the same hedging effect as commodities,” the group states.
Optimize debt
Finally, consider offloading debts that have high interest rates. If you have a mortgage with a high interest charge, get it refinanced at a lower fixed rate. When the inflation spikes, the fixed lower rate will save you money that would have been wasted in a variable interest mortgage. Additionally, avoid using credit cards during a high inflation economy.
