Inflation Investing: When To Buy and When To Hold

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One of the great things about investment markets is that there’s always an opportunity to make a profit, even when things are seemingly unfavorable.

When inflation rises, it costs companies and consumers alike more to build, produce and consume things, and this is generally seen as a negative. Yet there are still plenty of investments that do well during an inflationary environment, with some even thriving. Thus, the question isn’t so much when you should buy and hold during inflation, but what you should be owning.

Here are a few investments that typically prosper during inflationary environments, along with a few examples of ones you might want to avoid.

TIPS

Treasury Inflation-Protected Securities, or TIPS, are one of many securities issued by the United States government. TIPS carry the same backing and guarantees as all other Treasury securities, like Savings Bonds and Treasury Bills – but as the name implies, TIPS also have inflation protection built into their design. 

TIPS protect you from rising prices because their principal (face value) adjusts in line with inflation. When a TIPS matures, you receive either the inflation adjusted price or the original principal, whichever is greater. As an added bonus, the interest payments are based on the adjusted face value, so as prices rise, so will your interest earned.

These features make TIPS a highly defensive investment during inflationary periods.

Stocks

The stock market in general tends to sell off sharply at the first whiff of inflation. This is because spikes in inflation are typically countered by the Fed raising interest rates (as we’ve seen over the last year and a half), which normally leads to slower economic growth.

But after the initial downdraft, buyers tend to return to the stock market, because it offers growth characteristics that can counter the diminishing purchasing power caused by inflation. In other words, over the long term stocks typically have the ability to outgrow inflation much more than other investments.

For most people, the simplest way to invest in stocks is through a low-cost index fund, but more enterprising investors might consider looking at individual stocks, as some companies tend to outperform others during inflationary periods. For example, notes Derek Sall, founder of Life And My Finances, “When people start feeling the pinch on their wallets, they don’t stop going out to eat, they just stop going to the more expensive restaurants. McDonalds’ revenue rises sharply during inflationary periods.”

Commodities

Commodities can fluctuate sharply in price when inflation accelerates, in part because they are a big part of what goes into the calculation of the inflation rate itself. In particular, energy companies tend to be good bets in inflationary periods because they have a nearly unlimited capacity to raise prices. When the price of oil goes up, for example, so too do its end products, including gasoline.

Most Americans have little choice when it comes to their energy consumption, as they must still drive their cars to work and heat or cool their homes. In a pinch, workers can use public transportation or carpool, and they can suffer through unpleasant temperatures at home, but these are often options of last resort. Thus, commodity producers, especially energy companies, can be a defensive holding during an inflationary period.

Rental Property

In an inflationary environment, home prices tend to rise, and rents tend to follow. Landlords often raise rents to help counter the inflationary pressures they themselves feel, from rising energy bills to the increased cost of maintenance. Whether inflation is high or low, people still need a place to live, so landlords typically have the ability to raise rents without losing their tenants. This can make rental properties a good thing to own in an inflationary environment.

If, like most people, you don’t have the kind of cash sitting around that you’d need to buy a house or apartment building, there are still ways for you to get exposure to rental properties. Real estate investment trusts, or REITs, are companies that specialize in owning, operating, and financing income-producing real estate. Most REITs are publicly traded, so you can buy shares of them on the stock market (for a lot less than a house costs). If you prefer to be more diversified, there are also many ETFs (exchange-traded funds) that own a variety of different REITs and real estate companies.

Investments You Might Want To Avoid

The truth is that when it comes to investing, there are both winners and losers in any environment. Just as there are investments that benefit from rising inflation, there are others that suffer. Here are some of the options you’ll probably want to avoid:

Long-Term Bonds

Rising inflation is nearly always met with rising interest rates. This is due to a combination of the Fed raising rates to help corral inflation and investors demanding a higher return on their money. Long-term bonds are the most susceptible to rising interest rates, and their prices fall more than those of short-term bonds. At the start of an inflationary cycle, owning a long-term bond is one of the last places you want to be, as the price of your investment can fall sharply.

Think of it this way: If you own a 30-year bond paying 3% and newly issued bonds pay 5%, what investor will buy your bond? The answer is that none will, until the price of your bond falls enough to the point where its yield matches that of newer bonds.

Stock In Companies With Little Or No Pricing Power

Although the stock market can be quite resilient to rising inflation, there are individual stocks that don’t perform as well. While some companies can raise their prices to help offset rising material and labor costs, not all can.

This is because of a principle known as elasticity of demand. For any given product or service, demand for it will change as the price goes up or down. As mentioned already, energy and rental housing both tend to see demand fall slowly or not at all as prices go up – thus the demand for both would be called “inelastic.”

But obviously, not all demand is inelastic. Airlines, for example, can raise fares to a certain degree, but typically not to the point that they cover the increasing costs of fuel and onboard services. Whereas consumers might have to pay for food and energy no matter the cost, not many people are forced to fly. This limits the price that airlines can charge for their services, which leaves them more vulnerable to rising costs.

James Holbach contributed to the reporting for this article.

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