The Best Ways to Invest When Inflation Takes Off

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  • Inflation surged more in June than it has in more than 10 years, and the news has investors worried.
  • Rising prices can erode a portfolio's profit.
  • But there are some moves investors can take to shield their money from inflation — and even take advantage of the environment, experts say.

Inflation surged more in June than it has in more than 10 years, and the news has investors worried.

That's because rising prices can erode a portfolio's profit. Most simply, as the cost of living swells, your returns don't go as far.

That's a particularly tough challenge for retirees, who may rely mostly on their investment yields to pay their bills, whereas younger people still have a salary. And then there's the fact that inflation can cause the Federal Reserve to raise interest rates, which tends to be bad for equities.

"In general, inflation is usually negative for stocks," said Amy Arnott, a portfolio strategist at Morningstar.

She pointed to history: Between 1973 and 1981, inflation rose by more than 9% a year. During the same period, stocks shed about 4% annually.

But don't panic — doing so has never helped an investor.

First of all, we still don't know if rising prices will become the new normal or if they're just a temporary result of a nation emerging from a pandemic and a year of lockdowns and restrictions.

Either way, history shows that stocks beat inflation over the long term.

The average annual return on stocks was around 11% between 1900 and 2017, according to calculations by Steve Hanke, a professor of applied economics at Johns Hopkins University in Baltimore.

After subtracting the cost of inflation, that average annual return remains a handsome 8%.

Still, there are some moves investors can make to protect their money from inflation — and even take advantage of the environment, financial advisors say.

How to take advantage of rising prices

Alex Doll, a certified financial planner and president of Anfield Wealth Management in Cleveland, has been pulling back on his clients' exposure to growth stocks of late. And he's been increasing their allocation to value stocks, or companies trading at rates below average in the S&P 500.

"Value stocks can do a bit better during inflationary periods," Doll said.

That's because these companies are often in industries, such as the financial and consumer staples sectors, that get hit less hard by inflation, Doll said, "These industries tend to perform better because they have more pricing power and are able to increase their prices with inflation better than other industries."

These businesses are also usually already well established, he said, and so you don't have to worry as much about their expected growth waning in value.

Another good match for investors worried about inflation are Treasury inflation-protected securities, or TIPS, said CFP Nicholas Scheibner, a wealth management advisor at Baron Financial Group in Fair Lawn, New Jersey.

These securities carry a similar risk as other fixed income investments, he said, but they add an adjusted principal amount if inflation increases.

Other hedges to inflation include investing in real estate, gold and even cryptocurrencies, advisors say.

"Real estate performs well because landlords and property owners see the values of their properties increase," Doll said. "Also landlords can somewhat easily pass-through rent increases."

The argument for investing in cryptocurrencies or gold amid inflation is that those assets are not damaged by the eroding value of cash.

However, both are highly volatile and shouldn't make up more than 5% of your portfolio, experts warn.

Investments to avoid amid inflation

Because an interest rate hike by the Fed might be in store, experts recommend that you don't tie up too much of your money now in any long-term bonds or certificates of deposits. Doing so could lead you to miss out on higher rates later.

"I advise clients at present to focus on short to intermediate-term bonds and avoid any investments that have 'long term' in the name," said Doug Bellfy, a CFP at Synergy Financial Planning in South Glastonbury, Connecticut.

Another area you may want to stay away from is growth stocks, or companies with higher-than-average expected earnings, Doll said.

"Growth stocks tend to perform worse because they expect to earn the bulk of their cash flow in the future," Doll said. "And as inflation increases, those future cash flows are worth less."

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