When investing, your capital is at risk and you may get back less than invested. Past performance doesn’t guarantee future results.
How to invest during high inflation?
Are you worried your hard-earned investment returns will be eaten away by inflation? Here are some investment strategies and inflation hedges that could help.
Inflation means your money is worth less every year. And when inflation is very high, special steps can be taken to protect your investments.
Inflation means your money is worth less every year. And when inflation is very high, special steps can be taken to protect your investments.
Big ideas
- When inflation is high, investment returns tend to be lower because the purchasing power of the money invested decreases.
- In order to combat the effects of inflation, investors can invest in assets that are expected to increase in value at a rate higher than the rate of inflation.
- Five factors that can help inflation-proof your portfolio are sales, pricing power, commodities, interest rates and the economy.
What is inflation?
Inflation is an increase in the prices of goods and services over time. In short, the things you buy cost more than they did in the past. Inflation can be caused by a variety of factors, such as strong economic growth, accommodative monetary policy, and low supply of commodities and raw materials.
How to find the inflation rate
Inflation is usually measured as an annual percentage change. Every country produces different measures of inflation. Because western economies are dominated by consumption, the consumer price index (CPI) is the most widely followed.
Central banks like the US Federal Reserve or the Bank of England tend to target 2% annual inflation. This is what they refer to as “price stability.” So by that standard, 2% might be considered a normal level of inflation, while above or below 2% is abnormal.
Central banks like the US Federal Reserve or the Bank of England tend to target 2% annual inflation. This is what they refer to as “price stability.” So by that standard, 2% might be considered a normal level of inflation, while above or below 2% is abnormal.
Finding the best investment during inflation
When inflation is high, it can be difficult for consumers to keep up with rising prices because wage growth often doesn’t offset the higher cost of living - and this can lead to lower living standards.
Inflation can also eat into your investment returns and lower your wealth. Since investing is all about raising our wealth over the long term, understanding how to invest during high inflation absolutely requires your attention. When inflation is high, investment returns tend to be lower because the purchasing power of the money invested decreases.
Inflation can also eat into your investment returns and lower your wealth. Since investing is all about raising our wealth over the long term, understanding how to invest during high inflation absolutely requires your attention. When inflation is high, investment returns tend to be lower because the purchasing power of the money invested decreases.
Example
You invest $100 in a stock when inflation is 10%.
The stock price stays the same so it is still worth $100 after one year.
However, the value of your investment will be worth $90 in purchasing power.
Instead of that $100 being able to buy you ten Mcdonalds' Big Mac Meals, you will only be able to buy nine!
The stock price stays the same so it is still worth $100 after one year.
However, the value of your investment will be worth $90 in purchasing power.
Instead of that $100 being able to buy you ten Mcdonalds' Big Mac Meals, you will only be able to buy nine!
This is why they call inflation a ‘hidden tax’. In the previous example, the stock you own has not gone down in price but you just lost 10% of your wealth by owning it.
To find the best investment during inflation, investors need to find assets that are expected to increase in value at a rate higher than the rate of inflation. This can be done in one of two ways:
To find the best investment during inflation, investors need to find assets that are expected to increase in value at a rate higher than the rate of inflation. This can be done in one of two ways:
- Hedging against lower stock returns
- Stocks that do well during inflation
How to protect money from inflation
An inflation hedge is an investment that is designed to protect against the effects of inflation. Inflation can erode the value of investments, so a hedge can help to offset this.
The mainstay of a portfolio tends to be stocks and shares. If inflation is causing the stock market to drop, then other types of investments can be used to limit losses on stocks. There are different types of inflation hedges, including gold, commodities, real estate and Treasury inflation-protected securities (TIPS). It’s advisable to pay attention to the gold price during recession.
Fortunately, it is a lot easier to invest in these things today than it once was because they are all available through ETFs.
The mainstay of a portfolio tends to be stocks and shares. If inflation is causing the stock market to drop, then other types of investments can be used to limit losses on stocks. There are different types of inflation hedges, including gold, commodities, real estate and Treasury inflation-protected securities (TIPS). It’s advisable to pay attention to the gold price during recession.
Fortunately, it is a lot easier to invest in these things today than it once was because they are all available through ETFs.
In the Trading 212 app, if you go to search and tap ETFs, you can see REITS, Commodity funds and fixed income funds. Alternatively, you can just type in whatever you’re interested in, like TIPS, in the search field to find matching ETFs.
Watch our video
How to find the best stocks for inflation
Stocks don’t really fit under the category of an inflation hedge. The reason is that there is not a uniform impact that inflation has across the stock market due to the huge variation in businesses issuing shares. Historically, the stock market has both risen and fallen during periods of inflation. How inflation affects stocks depends on the type of stock and the economic environment in which the inflation is occurring.
Dealing with inflation takes a slightly different approach than to simply dealing with a down market. Again the stocks you own can rise in price when there is inflation but if they rise less than the rate of inflation, you are losing purchasing power.
Dealing with inflation takes a slightly different approach than to simply dealing with a down market. Again the stocks you own can rise in price when there is inflation but if they rise less than the rate of inflation, you are losing purchasing power.
What investment is good when there is inflation?
When thinking about inflation-proofing a portfolio, think about these five factors to find the best inflation stocks.
- Sales
- Pricing power
- Commodities
- Interest rates
- The economy
1. Stable earnings
If goods and services cost more then consumers and businesses will need to cut back purchases in some areas. Investing in companies that will not be on the receiving end of those cutbacks is one approach to investing during inflation. The companies that know how to make money during inflation are usually those that sell essential goods. Fortunately, there is a whole sector of such stocks called Consumer Staples.
On the Trading 212 app, tap the search icon to see all trading instruments. Under the stocks tab, select ‘browse all’. Choose the market you want to invest in and then select ‘Consumer staples’.
Here you can see some of the household names that you probably buy from every week, including the likes of Tesco and Unilever in the UK or Procter & Gamble and Walmart in the US.
Here you can see some of the household names that you probably buy from every week, including the likes of Tesco and Unilever in the UK or Procter & Gamble and Walmart in the US.
2. Pricing power
Pricing power means that a company can raise prices with minimal effect on its sales. When there is inflation, companies will have to spend more on supplies. If they can raise prices, they can pass on the higher costs to their customers and maintain profit margins.
This might at first glance be a harder statistic to seek out but a good proxy for pricing power is gross margins. That’s because you need pricing power to have handsome profit margins in business. Otherwise the competition will step in and take away your business by accepting slightly lower margins.
This might at first glance be a harder statistic to seek out but a good proxy for pricing power is gross margins. That’s because you need pricing power to have handsome profit margins in business. Otherwise the competition will step in and take away your business by accepting slightly lower margins.
In the app, after you’ve tapped your chosen stock, you can scroll down to key ratios and then tap ‘More Ratios’. Now scroll along the top tabs to ‘Margins’. The closer the margins are to 100% the better.
Here you can see that five-year gross margins are high at 83%. Then if you scroll down to net profit margin and operating margin, it all looks secure too.
Here you can see that five-year gross margins are high at 83%. Then if you scroll down to net profit margin and operating margin, it all looks secure too.
3. Raw materials
High inflation often starts with the rising price of raw materials. This is known as cost-push inflation. When demand for a commodity surpasses supply, the price of the commodity should go up. A higher price for commodities will tend to lead to higher profits for companies that produce and sell them.
Commodity producers include miners, the biggest of which tend to be Australian like BHP, and Rio Tinto or headquartered in the UK with operations overseas like Anglo American, Glencore and Antofagasta. Oil companies are another kind of commodity producer. Most of us know Big Oil companies like BP, Shell, Exxon and Chevron, but there are many others.
The other side of the equation is rising raw materials prices can lead to higher costs for companies, which can eat into their profits. Finding companies that don’t depend on the cost of raw materials can also inflation-proof your portfolio.
Commodity producers include miners, the biggest of which tend to be Australian like BHP, and Rio Tinto or headquartered in the UK with operations overseas like Anglo American, Glencore and Antofagasta. Oil companies are another kind of commodity producer. Most of us know Big Oil companies like BP, Shell, Exxon and Chevron, but there are many others.
The other side of the equation is rising raw materials prices can lead to higher costs for companies, which can eat into their profits. Finding companies that don’t depend on the cost of raw materials can also inflation-proof your portfolio.
4. Interest rates
The job of central banks is to keep prices steady. When there is inflation, central bankers will normally jump into action to reverse it by raising interest rates. The stocks that should benefit the most from higher interest rates are banks. The core measure of a bank’s profitability is its Net Interest Margin. That’s the difference between the interest income generated from borrowers and the amount of interest paid out to lenders.
When interest rates rise, the difference between what banks earn and spend in interest tends to rise, earning them higher profits. But there is a big caveat. If the inflation is driven by high demand in a strong economy, then banks should benefit. However, if the inflation is happening in a weak economy, for example because of supply constraints, then it's likely the inflation will cause more loan defaults, which could offset any benefit the banks get from higher interest rates.
When interest rates rise, the difference between what banks earn and spend in interest tends to rise, earning them higher profits. But there is a big caveat. If the inflation is driven by high demand in a strong economy, then banks should benefit. However, if the inflation is happening in a weak economy, for example because of supply constraints, then it's likely the inflation will cause more loan defaults, which could offset any benefit the banks get from higher interest rates.
5. The economy
The context in which inflation is happening really matters for your choice of investments. A Strong Economy tends to see strong demand outpace the supply of goods and services, which leads to inflation. This is healthy and good and a sign of economic expansion. In that environment, it makes sense to own cyclical stocks that perform in line with the economic cycle. That can include airlines, hotels, retailers and banks. On the flip side, if inflation causes an economic downturn, then it makes sense to own non-cyclical stocks. Consumer staples, utilities and pharmaceutical sectors are all non-cyclical sectors.
Recap
Keep in mind that inflation isn’t the only thing affecting our portfolio. You want to take account of inflation while taking a holistic approach to portfolio construction that accounts for all the different variables and always focus on your long-term investing goals.
FAQ
Q: How does inflation affect investments?
Inflation affects investments because when the prices of goods and services rise, the value of money decreases. This means that investors need to put more money into their investments to get the same return. Inflation can also make it difficult to predict future returns on investments, which makes it harder to make investment decisions.
Q: How does inflation affect stocks?
Inflation affects stocks firstly via the earnings of companies, as inflation can increase the cost of inputs and reduce the purchasing power of consumers. This can lead to lower profits and share prices.
Secondly, inflation can also affect the valuation of stocks. When inflation is high, the real value of stocks and other assets can decline, as the value of money itself decreases. This can lead to investors selling off stocks in order to buy assets that are less likely to lose value. Inflation can also lead to higher interest rates, which can make stocks less attractive compared to other investments.
Secondly, inflation can also affect the valuation of stocks. When inflation is high, the real value of stocks and other assets can decline, as the value of money itself decreases. This can lead to investors selling off stocks in order to buy assets that are less likely to lose value. Inflation can also lead to higher interest rates, which can make stocks less attractive compared to other investments.
Q: How inflation affects the price of commodities?
When inflation increases, the prices of commodities also tend to increase. This is because the cost of production for commodities generally goes up when inflation goes up. For example, if the cost of fuel and raw materials goes up, the cost of producing commodities such as food and clothing will also go up.
Inflation can also affect the prices of commodities in another way. When inflation decreases the value of money, people may start to buy more commodities instead of holding onto their money. This increased demand can cause the prices of commodities to go up.
Inflation can also affect the prices of commodities in another way. When inflation decreases the value of money, people may start to buy more commodities instead of holding onto their money. This increased demand can cause the prices of commodities to go up.
Q: How inflation affects real estate?
When inflation is high, it can lead to higher prices for things like land, buildings, and construction materials. This can make it harder for people to afford a home or an investment property. Inflation can also make it difficult to get a mortgage, because lenders may need to charge higher interest rates if inflation goes up to ensure they get the full value of their money back.
Q: How does inflation affect interest rates?
Inflation is one of the most important factors in determining interest rates. When inflation is high, interest rates are typically high as well, because lenders want to protect themselves from the effects of inflation. When inflation is low, interest rates are usually low as well, because lenders don't need to worry as much about the effects of inflation.
Q: What are the pros and cons of investing in high inflation?
On the plus side, inflation can be a tailwind for investments, pushing up prices and increasing returns. This can be especially beneficial for assets that are inflation-indexed, such as government bonds. On the downside, inflation can erode the value of investments, eating into returns and reducing purchasing power. This is why it is important to consider inflation when making investment decisions.
- Consumer Price Index (CPI): A measure tracking the average change over time in the prices paid by consumers for a basket of goods and services.
- Treasury Inflation-Protected Securities (TIPS): Government bonds that adjust their principal value with inflation, helping to safeguard investors’ purchasing power.
- Cyclical stocks: Shares of companies whose performance tends to follow the economic cycle, rising during booms and falling in downturns.
- Non-cyclical stocks: Shares in companies that provide essential products or services, exhibiting relatively stable performance regardless of economic fluctuations.
- Gross Margin: A measure of a company’s efficiency, calculated as the difference between revenue and cost of goods sold, expressed as a percentage of revenue.
