Before investing, every investor is keen to know the risks his portfolio face. Inflation is one of the risks that face every investor. Inflation is a situation where money loses value over time. As a result, it reduces the value of an investment over time. Due to the current global inflation, every investor is looking for a way to hedge their investment against inflation. For instance, there are investments that are designed to hedge against inflation.
In this article, we are going to highlight how to hedge against inflation.
Hedge Against Inflation Meaning
To hedge against inflation means to protect against inflation. They are measures you can take to ensure that your investments do not lose value over time due to inflation. There are some investments that protect investors' investments from depreciating due to inflation.
How Does Hedging Against Inflation Work?
Hedging against inflation means taking measures to protect the value of your investments from losing value over time due to inflation. An example, if you have an investment whose value increases by 3% and the rate of inflation is 5%, then the rate of return of that asset is -2%. To avert this scenario, there are measures you can take to hedge your portfolio against inflation. Let’s take a look into these measures.
What is the Best Hedge Against Inflation?
Gold is considered to be the best hedge against inflation. Gold is able to keep up with the rate of inflation and it is the reason why it is used by many countries to back their currencies against inflation.
Also read: Will the cost of living go down UK?
What are the Best Hedge Against Inflation?
The following are some investments that can help you hedge against inflation.
1. Gold Hedge Against Inflation
Gold is the best hedge against inflation. Other precious metals such as silver can also be used as a hedge against inflation. Most countries use gold to back their currencies against inflation. It is because gold is able to keep up with inflation; its value increases when the rate of inflation rises.
2. Stocks Hedge Against Inflation
Stocks can be used as a hedge against inflation because their prices have a positive correlation with inflation. As the rate of inflation increases, businesses increase the price of goods and services. In return, their revenues increase. This makes the price of stocks rise. However, stocks face price volatility risk, unlike other assets.
Some of the stocks to hedge against inflation include energy stocks that have continued to perform well even during periods of elevated inflation.
Read more: How to invest in stocks for beginners UK.
3. Real Estate Hedge Against Inflation
Real estate income is also a good hedge against inflation. Real estate income increases with a rise in inflation and so do real estate properties. As the rate of inflation increases, landlords also increase rental charges. This helps them to keep up with the pace of inflation. This makes real estate one of the best hedges against inflation.
4. Commodities Hedge Against Inflation
Commodities such as precious metals, oil, natural gas, and foreign currencies have a positive correlation to inflation. As the rate of inflation rises, so does the price of these commodities. You can invest in commodities through Exchange Traded Funds (ETFs). However, when investing in commodities, investors need to be aware that commodities are highly volatile because their prices depend on demand and supply.
5. TIPS Hedge Against Inflation
Treasury Inflation-Protected Securities (TIPS) are some kind of treasury bonds that can be used to hedge against inflation. The principal value of TIPS changes based on the rate of inflation. TIPS pays interest twice a year and the payouts are usually fixed. TIPS are available in three maturities; 5 years, 10 years, and 30 years. There are drawbacks to investing in TIPS in that their yields are usually so low.
6. REITs Hedge Against Inflation
Real Estate Investment Trusts (REITS) are public traded companies where investors pool funds together and invest in trusts. In return, REITs pay dividends to investors. Rental income and property prices tend to rise with a rise in the rate of inflation. As such, REITs can adjust rental income upwards when the rate of inflation increases.
However, investing in REITs have some drawbacks in that they are sensitive to demand for other high-yield assets. What it means is that an increase in interest rates can make treasury securities more attractive thereby lowering share prices for REITs.
7. Floating-rate Bonds Hedge Against Inflation
Bonds have a fixed payment during their lifetime. Also, when the rate of inflation increases, their payouts tend to increase. You can buy a floating-rate bond through ETFs or mutual funds. One of the benefits you will reap is diversification, thereby lowering risks for your portfolio.
Frequently Asked Questions on How to Hedge Against Inflation
Below are some questions people often ask about how to hedge against inflation.
Is Gold a Hedge Against Inflation?
Yes. Gold is considered the best hedge against inflation. In fact, many countries around the world use gold to back their currencies against inflation. That’s why most central banks around the world hold gold to earn interest and use it as collateral for market loans.
Is Real Estate a Good Hedge Against Inflation?
Yes. The value of real estate properties and rental income tends to increase with an increase in the rate of inflation. Landlords are usually keen to increase rental income rates when there is a considerable increase in the rate of inflation.
Is Crypto a Hedge Against Inflation?
In 2021, Bitcoin outperformed both gold and stock as a hedge against inflation. Bitcoin's high performance in 2021 made El Salvador adopt it as a legal tender. However, the value of bitcoin and many other cryptocurrencies dropped in 2022.
However, the extreme volatility of cryptocurrencies has raised questions about whether bitcoin can be used as a hedge against inflation. Due to its consistent fall starting end of 2021 to date, cryptocurrency is not a good hedge against inflation.
Summary of How to Hedge Against Inflation
One of the risks investors are faced with is inflation. As the rate of inflation increases, the value of most investments tends to fall. However, there are some investments like the ones mentioned above that can help you hedge against inflation. However, while investing, you need to be on the lookout for other risks like volatility risks.