How Do You Hedge Against Inflation? What Advisors Say

Inflation is a factor in all of our daily lives. Whether you’re buying groceries or a new car, the rising costs of goods and services reduce your purchasing power over time. Even if you’re wealthy, the impact can be noticeable on your finances.

Because of the impact inflation has, it’s important to guard, or hedge, against it. This involves investing your money to decrease the effects of rising costs on your purchasing power, including holding less cash and buying assets that increase in value over time.

This article will further explain what it means to hedge against inflation, as well as what you should consider beforehand. Additionally, we include expert commentary from financial advisors on the strategies, investments, and challenges you may face as you protect your purchasing power from rising costs.

What Is Inflation?

Inflation refers to the consistent rise in the cost of goods and services. This impacts consumers’ purchasing power. That is, they’re unable to buy as much with the same amount of money.

The root cause for inflation typically is due to supply and demand. For instance, as the market for a particular resource or item rises above its supply, the cost is likely to increase. Inflation is commonly tracked via the Consumer Price Index (CPI). As of August 2024, the CPI’s 12-month percentage change was 2.5% for all items.

How Inflation Affects Your Portfolio

While inflation can impact the purchasing power of your cash, it can also affect several other areas of your portfolio. This includes:

• Fixed-income securities. The purchasing power of income earned through bonds can diminish due to inflation. This is because the returns they generate remain at the same rate as when you bought them.
• Stocks. Periods of high inflation can reduce your returns from stocks. If your returns are at a percentage that isn’t outpacing the CPI rate, you could see negative effects.
• Commodities. Because inflation signifies rising costs of goods and services, the price of commodities, such as precious metals and agriculture, also increases.
• Real estate. Inflation can increase the price of building materials and maintenance costs. For this reason, home and rent prices may increase during periods of rising costs or due to higher demand for housing.

What It Means to Hedge Against Inflation

Hedging against inflation refers to strategically investing to lessen the impact of rising costs on your purchasing power. This typically involves buying assets that either keep pace with or outperform inflation. By doing so, your money goes further as you plan for future life goals.

Jordan Taylor, an independent financial advisor at Core Planning in Birmingham, Alabama, explains the importance of protecting against rising costs, “Inflation is, usually, inevitable. Every few years, your dollars will buy less stuff. If you want to buy a home in 5 years? If you want to go on a dream vacation in 2 years? If you want to retire in 20 years? You need to save enough to beat inflation.” In other words, accounting for and hedging against inflation is crucial to make it easier to reach your goals.

Assets That Hedge Against Inflation

According to Matt Willer, Managing Director of Capital Markets and partner at Phoenix Capital Group Holdings, LLC, “Hedging against inflation means owning assets that will defend against or appreciate alongside a less valuable dollar.” Many investments fit into this category, such as stocks, fixed-income securities, real estate, and commodities. Willer adds that the “best hedges against inflation are asset classes that are always negotiable at a market price.”

Here’s a breakdown of the types of investments people commonly use to hedge against inflation:

Equities

Equities are one of the ways you can hedge over time. Taylor identifies the most effective “investments for hedging against inflation” as those that “go up over time.” He adds that, for the “average American, that means index funds…stocks.” For instance, the S&P 500 had an annualized return of over ten percent in the last decade, increasing from 2,002.28 on September 2, 2014, to 5,528.93 points on September 3, 2024.

Commodities

Commodities, such as precious metals and energy, are another option investors commonly use to hedge against inflation. This is because their prices are typically contained within the CPI, allowing them to keep pace with rising costs. Be aware, however, that these can be volatile and don’t tend to offer any means of income besides any realized gains.

Real Estate

Inflation can impact both rent and home prices. For this reason, real estate is often an option to protect yourself against inflation. This can come in the form of owning properties, either for their value appreciation or to rent out, as well as shares of real estate investment trusts (REITs). REITs are investment companies that own and operate income-generating properties. They’re more liquid than traditional real estate investments, typically allowing you to buy and sell shares at will.

Treasury-Inflation Protected Securities (TIPS)

TIPS are a fixed-income security that can protect you against inflation. According to Eric Croak, CFP^®, president at Croak Capital, these are “federally backed bonds whose principal is adjusted periodically based on the change in the [CPI].” The principal amount increases with inflation, which also ensures the interest adjusts commensurately. For this reason, Croak describes TIPS as “a straightforward and potent shield against inflation. There is no way your principal can be eroded by inflation by rising prices.”

Challenges to Consider

While inflation can endanger your money over time, it’s also important to consider the challenges and dangers of investing to guard against it. Namely, any time you invest, there is a certain level of risk. “Any time you get the opportunity to grow your money (that’s the hedge against inflation), you get the opportunity to lose your money,” says Taylor.

Another risk, according to Taylor, is that “focusing on hedging against inflation might lead you to make more conservative decisions.” While it’s important to protect the integrity of your purchasing power, it’s also important to ensure you have a long-term investment strategy in place that will yield lasting results.

What You Can Do to Hedge Against Inflation

Knowing which assets can protect you from inflation is a good start, but it becomes more complex to weave them into your portfolio in a way that matches your goals, risk tolerance, and time horizon. Taylor recommends typical “diversification” because news of inflation spikes “can move the stock market negative.” This makes it important to own different types of assets, such as fixed-income securities or, in some cases, alternatives.

Similarly, Croak suggests investors employ a “layered defense” approach to portfolio management. “This is where your portfolio is balanced with different assets that react in different ways to different economic conditions,” he explains. In this method, Croak is a proponent of growth stocks, which “have tended to perform better during inflationary periods because the company can raise prices to reflect inflation.” By adding a layered approach, you are “less susceptible to inflationary shocks, while at the same time positioning for growth in mix-and-match scenarios. It’s not putting all your eggs in one basket. It’s putting each egg in a different basket, so that, in the end, you have a basket full of sturdy eggs,” continues Croak.

Aside from investing to hedge against inflation, Thomas J. Brock, CFA, CPA, an expert contributor at Annuity.org, explains that the “most effective approach is to maintain a flexible budget, whereby you temporarily adjust living expenses downward during challenging times.” This can include cutting back on discretionary spending and keeping a monthly budget to ensure you’re on track. Doing so can help you retain more of your income each month to save and invest as you see fit.

Ultimately, the approach you choose to guard against inflation should be one tailored to your preferences, such as your goals and risk tolerance. We recommend speaking with a financial advisor before you commit to any approach. To find a high-quality professional near you, consider this free matching tool, which will present you with a vetted option according to your needs.