When inflation continues to rise and ongoing market volatility brings up questions of a possible bear market, investors are looking for ways to protect their portfolios. Researching and learning how to invest in a recession is a good way for investors to approach the period ahead, though the rising inflation itself requires special attention.
Inflation hedging is one of the many strategies investors need to take into account as the value of the dollar drops. And fortunately, there are a number of ways you can protect your assets as rising inflation grips the nation. The first step is learning what inflation does to the stock market. And once you know what you’re up against, you can take steps to hedge your capital against inflation.
In this article, we’re going to talk all about hedging inflation. You’ll learn a few of the most effective ways to hedge against inflation along with valuable tips to help you preserve & protect your capital. First, let’s take a look at what inflation is before we discuss what is a hedge against inflation.
What Is Inflation?
Before we get into strategies for hedging inflation, let’s discuss what inflation is exactly. Inflation is a natural occurrence in the economy. It occurs when there is a rise in the costs of goods and services and the purchasing power of a given currency falls. So, during inflationary periods, people can buy less of a good with the same amount of currency as they could previously.
Now that you have a better understanding of what inflation is, let’s discuss hedging so we can dig into strategies for hedging inflation.
What Is Hedging?
Hedging is a form of risk management for investors. Typically, this strategy is utilized to offset potential losses from a current position without having to sell the security. It is an advanced strategy typically used by institutional investors, though individuals can benefit from a hedging strategy when leveraging the right tools and analysis.
Oftentimes, investors will short stocks, short ETFs, or embrace value investing strategies in order to hedge against the potential decline of certain long positions in their portfolios. So, keeping the principles of hedging in mind, let’s explore what is a hedge against inflation and how investors manage their portfolios during inflationary times.
So, What Is A Hedge Against Inflation?
Now that you know what both hedging and inflation mean on their own, let’s put them together and discuss hedging against inflation.
Taking these two principles together, inflation hedging is when investors utilize a specific strategy to offset the deteriorating effects of inflation in their portfolios. Preventing the loss in value or decline in purchasing power are both priorities of hedging inflation, which is possible through certain strategies.
Why Is Inflation Hedging So Important?
Hedging inflation is crucial for investors because it’s how they can protect the value of their assets. To help you understand why, let’s look at a real-world example. Say you experienced gains in certain investments, like 4% annually. But, you were technically at a loss if the inflation outpaced these gains at 5% for the year.
And frankly, 5% inflation is a modest estimation. In 2021, we experienced an inflation rate of 7% – and halfway through 2022, the rate of inflation is at 8.6%. Thus, your gains need to exceed 10% annually – just to see any profit from your investments.
So, it’s important for investors to factor in inflation when calculating their portfolio returns, especially during periods of rising inflation. But, is there anything you can do about it? Let’s take a look.
What Is An Inflation Hedge Investors Can Use To Minimize Risk?
After learning about inflation and that it’s possible to hedge against its effects, you may still be wondering what is a hedge against inflation investors actually utilize. There are a number of ways that investors can hedge against inflation and protect the value of their portfolios. So, let’s take a look at some of the best strategies available to investors:
Historically, the S&P 500 has performed well during periods of high inflation. For instance, the years with the highest inflation in recent decades were 1979 and 1980 with inflation rates of 13.6% and 11.3%, respectively. During that same time, the S&P 500 index saw impressive returns of 18.5% in 1979 and 31.7% in 1980.
Of course, there are instances where the S&P 500 suffered during inflationary periods, though over the long run the trends show that this index outperforms the rate of inflation and is a valuable asset. Thus, investors with a large portion of their portfolio in bonds can consider reallocating to stocks to outpace inflation as opposed to hedging against inflation.
Real Estate ETFs
Another tool that investors have to hedge against inflation in the stock market is to buy real estate ETFs. When inflation is rising, real estate tends to perform well, as there is an intrinsic value to these assets through the value of the properties.
Plus, property values increase with inflation, and there will always be a demand for homes and real estate no matter the state of the economy. Therefore, investors in the stock market can benefit from these qualities by owning real estate ETFs as inflation rises.
TIPS, or Treasury inflation-protected securities, are often utilized in hedging inflation strategies. While they’re not bought and sold on the stock market, many investors still choose to purchase these securities during inflationary times. This is because, as the name suggests, they are U.S. Treasury bonds that are created to increase in value alongside inflation.
Backed by the U.S. and linked to the Consumer Price Index (CPI), a principal way of measuring inflation, TIPS are viewed as very safe investments to hold, especially as inflation rises. However, the long maturity dates of TIPS keep investor funds locked up for a meaningful amount of time.
Keep In Mind – Inflation Hedging Has Its Limitations
It’s important to remember that even though inflation hedging strategies can be powerful when executed correctly, there is a limit to how much risk they can offset. Plus, hedging in general can be a somewhat difficult strategy to get the hang of. Oftentimes hedging inflation requires investors to enter additional positions, which could be costly depending on the exact scenario and investment to be hedged. Additionally, inflation hedges may not result as they were intended if the risk doesn’t cause as much downside as expected.
But, with the right resources and tools, you will start off on the right foot. This guide is a great starting point – from here, you can read up on our articles discussing how to hedge against inflation, or perhaps more relevantly, the best hedge against inflation. These resources paired with the right tools – like a stock forecasting tool – will help you stay ahead of inflation. More on that later. First, we’re going to leave you with a few tips for getting started hedging against inflation and staying profitable despite unfavorable conditions.
Tips For Hedging Inflation & Staying Profitable Despite Unfavorable Conditions
We’ve now answered the question – what is an inflation hedge? – and explained how investors protect the value of their assets from inflation. Before bringing things to a close, we want to provide some additional tips that investors should be aware of before they start hedging against inflation.
Even when entering into certain positions in order to hedge against inflation, make sure you are maintaining a good level of diversification that aligns with your overall investment strategy. Inflation hedges are generally short-term strategies, but keep your long-term objectives in mind to prevent unwanted exposure in your portfolio.
Consider the Tax Implications
When utilizing hedging strategies, investors may buy and sell a number of securities in a string of short-term positions. When doing so, they may make themselves liable to capital gains taxes on any profitable trades. Therefore, this is an important aspect to price in when looking to hedge inflation in the stock market.
Work Smarter With The Right Tools
Earlier, we said that correctly hedging inflation can get tricky – if you don’t have the right resources and tools. Well, you have the resources – and now we’re going to introduce the #1 tool for staying profitable no matter the market conditions.
You can get stock forecasting tools to uncover opportunities on autopilot – VectorVest’s software features pre-configured searches and scanners to help you identify your next play. There’s always an opportunity to make money in the market, investors just need to be more strategic with their approach. And our software helps you do just that – taking any of the guesswork out of investing and allowing you to feel confident in any decision you make.
With VectorVest, you can gain real-time and actionable insights on what stocks to buy and when to buy them. This will prove invaluable in helping you perform better and achieve clarity on what trades to make at any given time. Check it out with a free stock analysis tool and see the difference yourself – you’ll never go back to investing the old-fashioned way!
What Is An Inflation Hedge? Final Thoughts On Inflation Hedging
Even as inflation rises, investors have a variety of ways they can hedge their portfolios and protect the value of their investments. By investing in the stock market, increasing exposure to real estate, and considering a number of other securities like TIPS, investors can help offset the risks of inflation and retain value no matter the current market conditions.
When it comes to entering into inflation hedging strategies, it’s important that investors have access to a reliable source of information. This can provide them with clear recommendations that help them stay profitable in any economic state. Therefore, investors should invest in quality stock forecasting software to help make informed decisions and accurately time the market.