Investors should find the best way to protect their portfolios during turbulent periods. Fortunately, that’s what an inflation hedge does!
However, many still don’t know the term or don’t understand what it involves, especially if they’re starting out in the finance world.
Luckily, you can find all the information you need here! Do you want to know what an inflation hedge is and how it can help you protect your hard-earned money? Read on!
Understanding What An Hedge Against Inflation Is
After hearing the term for the first time, you may have a question in mind: “What is an inflation hedge?” Well, I’m here to answer that!
Essentially, an inflation hedge is an investment people usually make to protect their portfolio when a currency has decreased purchasing power.
Overall, currencies can lose some of their value due to rising prices, which often result from growing inflation.
Therefore, an inflation hedging strategy involves investing in assets that often maintain their value or experience price gains over time.
Many investors also take a higher position in assets as part of their inflation hedging strategy, as this action means that these investments will lose value less quickly than currencies.
What Is the Best Inflation Hedge?
Different asset classes can protect your investment portfolio when inflation hits and prices rise. However, gold is the best option to consider, whether you’re an expert or a beginner.
Rising inflation is a major concern for most investors. However, gold is an effective hedge against this event.
Here are a few of the reasons why you should consider buying this precious metal during turbulent economic times:
Gold is a liquid asset that you can sell quickly and without experiencing financial loss.
Since precious metals aren’t correlated with other assets, they’re ideal for diversifying investment portfolios.
Historically, gold has performed well during periods of economic uncertainty.
Gold can not only protect investments against inflation but also against deflationary pressure.
Let’s learn more about this precious metal and how it can protect your money.
How Inflation Hedging Works
As mentioned, inflation hedging can protect the value of your investment in turbulent scenarios.
Even if your investment seems robust and provides a decent return, it may be sold at a loss when the inflation rate rises to record highs. That’s what usually happens in the stock market.
When you buy a stock that gives a 5% return, but inflation is at 7%, you’ll be losing 2% of the money you invested.
However, that’s not the case with all assets. Some alternatives are considered inflation hedges because they have an intrinsic value that attracts many investors when the economy falters.
What About Gold?
Gold, the world’s most popular and coveted precious metal, is considered a hedge against inflation because its price in US dollars often varies.
When inflation rises, making the dollar lose value, gold usually becomes much more expensive. In these cases, if you hold this precious metal in your portfolio, you’ll protect your hard-earned money even if the currency falls.
Overall, gold maintains its value even if inflation erodes a currency’s value. As a result, the price people often pay for just one ounce of gold goes up.
If you’re a gold owner, you may be reap great rewards if inflation continues to soar. Here is a guide I wrote with more in depth information on investing in gold.
A Real-World Example of an Inflation Hedge
Let’s check this real-world example to understand how an inflationary hedge works.
Some companies and organizations use inflation hedging as a financial strategy to keep their operating costs down.
In 2021, Delta Airlines purchased an oil refinery from ConocoPhillips, Alaska’s largest crude oil producer. The main objective of this purchase was to offset the financial risks posed by rising jet fuel prices.
However, this example is not unique and extraordinary. Many airlines hedge their fuel cost in the crude oil market.
Delta’s plan had a major purpose: the company hoped to produce its own jet fuel at a lower price.
Since this expense would have been below the cost of purchasing jet fuel on the market, Delta would hedge against inflation in jet fuel prices.
When implementing this strategy, the company estimated that its year-over-year fuel expense would be at least $300 million lower.
Limitations of Inflation Hedging
Although it may favor most investors, inflation hedging has a few limits. In addition, the risk of volatility is high.
There’s another thing we can learn about what Delta did to offset inflation in jet fuel prices. The company has failed to make enough money from the oil refinery it bought from ConocoPhillips in 2012.
In other words, its inflationary hedge has not been as effective as expected. Why did this happen?
Well, there are mixed opinions about investing in commodities as inflationary hedges. Most of them consider different variables, such as technological innovation, global population growth, and production levels.
Chinese economic growth and infrastructure spending at a global level could also influence the effectiveness of commodity investments and their performance against inflation. Additionally, all of these factors are constantly changing.
Ways Investors Can Protect Their Portfolio Against Inflation
What should investors do when there’s rising inflation? Recent years have brought major changes, as governments pumped millions of dollars into the economy and interest rates rose to deal with the effects of the Covid-19 pandemic.
However, prices are still rising, so investors should still consider assets offering inflation protection for their portfolios.
Many people become borrowers and get fixed-rate loans when inflation rises. This strategy allows them to use fewer dollars to pay off their debt in the future.
Real estate investments are many people’s favorites when using certain types of debt to add assets to their portfolios.
However, as I mentioned, I believe there are other great inflation hedges, including gold and other precious metals. These are, definitely, the best ones.
Find more information about these options below:
Precious metals, particularly gold, are often considered safe-haven assets for most investors when interest rates are too low or inflation reaches high levels.
If real interest rates are low, gold and other precious metals tend to attract more investors since they store value if there’s economic uncertainty.
Fortunately, gold has been an excellent inflationary hedge for years. However, there are now more ways to invest in this precious metal.
Besides buying physical gold, such as coins and bars, investors can also purchase an exchange-traded fund (EFT). This asset has gained popularity because it allows people to invest in this coveted precious metal without owning, storing, and protecting it themselves.
While EFTs allow people to own physical precious metals, most investors put their money into gold miners’ stocks. These assets offer great advantages when gold prices soar.
Not just gold, but also silver. Which is why I created this guide to silver investing for beginners.
Treasury Inflation-Protected Securities (TIPS)
Also known as TIPS, Treasury inflation-protected securities can also be good options to protect portfolios when inflation revs up. However, they’re particularly advantageous for investors who have put their money into government bonds.
Many investors choose TIPS because Treasury bonds are indexed to inflation. Therefore, the effective interest rate paid on them rises or falls depending on whether inflation moves up or down.
Since bonds offer fixed payments, they are somewhat exposed to rising inflation, too. However, floating-rate bonds mitigate this effect.
In these cases, the payout increases when interest rates rise due to inflation. Investors often buy these assets through ETFs and mutual funds to diversify their portfolios.
Real Estate Investments
Many people don’t think about buying a home when figuring out the best strategy to protect their investments against growing inflation.
However, using a mortgage to make real estate investments can be quite beneficial. If rates for long-term mortgage loans are low, you’ll pay cheaper funding over 30 years, for example.
While property taxes may go up, monthly housing payments remain the same. Also, if you’re lucky enough, you can benefit from price appreciation.
Stocks are other popular investment alternatives for many people looking for a hedge against information. However, not all stocks offer this benefit.
Ideally, investors should only put their money into companies with pricing power that can raise prices on their customers if their spending also increases.
Final Thoughts – What Is the Best Inflation Hedge?
While you can buy a Treasury bond or stock to enjoy a few financial benefits and protect your portfolio during inflation, gold is undoubtedly the best inflationary hedge.
This precious metal has real-world uses in different industries, such as electronics and jewelry, which add tangible qualities to its value. Plus, market fluctuations don’t usually affect gold prices as they do with other assets or alternative investments.
In addition, the supply of gold is limited, which means that there will always be many investors interested in this asset. This also makes its value rise when there’s economic uncertainty.
Gold also offers many other benefits, as it’s a liquid asset. In simple words, you don’t have to wait for ages in order to find a good buyer willing to pay a fair price. Also, you won’t likely experience significant losses when selling it.
As a result, gold and other precious metals are the best inflation hedges today’s investors can consider.