Are your investments outpacing inflation?

How inflation impacts investors

If you're an investor who's comfortably retired, you and your financial advisor have probably shifted your investments towards wealth preservation instead of growth. A conservative, income-producing portfolio yielding 5% will still keep you ahead of inflation when inflation rates are the target 2%. But when inflation rises to 6.2%,1 like it did in October 2021, your income-producing portfolio is now effectively losing money.

Even investors with portfolios yielding the average 10% to 11% rate of return of the S&P 500 have to take stock of steep inflation. Once inflation is factored in, those returns dwindle to 3.8% to 4.8% — even less if you have accounts where capital gains taxes are a consideration.

When your investments fail to keep pace with or outpace inflation, you'll burn through your savings at a faster rate and potentially find your lifestyle and financial capabilities hindered.

How hedging helps combat inflation's impacts

There there's no telling whether prices will continue to rise. But there is a strategy that can help you manage inflation's impacts long-term. It's called hedging.

Hedging is investing in asset classes that tend to behave in ways that cushion the impacts of inflationary times. Just as bonds tend to increase their yields when the economy declines, other asset classes can become shock absorbers by bringing returns and delivering income.

While your financial goals and risk tolerance are unique, the asset classes below are commonly used to help investors hedge against inflation. By learning a bit about the "superpowers" of each asset class, you can use that info to start a conversation with your investment advisor.

• U.S. Large Cap Dividend Growth Stocks. Many large U.S. companies have steady track records of consistent dividend growth. The income from quarterly dividend payouts can potentially help offset declines in stock value.
  
  
• Real Estate Investment Trusts (REITS). It's easy to forget that the CPI includes rents. So when prices go up, rents tend to go up too. According to Nariet, a global organization that advocates for REITbased investments, REIT dividends have out paced inflation6 in all but two of the past 20 years.
  
  
• Private Real Estate. In times of inflation, home prices typically rise. In fact, home prices increased 18.1% year-over-year as of August 2021.4 While the pandemic may have contributed to this increase, in general your properties can increase in value even when the broader economy stalls. That's because the Fed typically keeps interest rates low to increase spending during an economic downturn. This, in turn, keeps mortgages accessible and home sales flowing. With robust sales, supply remains limited, so prices can increase even when the economy is otherwise slowing down.
  
  
• Commodities. According to research published by Vanguard, a 1% rise in inflation would produce a 7% to 9% rise in commodities.5  Commodities can include gold, agricultural products, and natural gas. You can invest in these through a wide variety of investment products, such as mutual funds, ETFs, and managed futures.
  
  
• Treasury Inflation-Protected Securities (TIPS). Issued by the U.S Treasury, these bonds adjust along with inflation. When inflation goes up, the principal value of TIPS also increases. In theory, this makes it difficult for investors to lose money.

While these aren't the only hedges against inflation, they show the wide array of investments that can help diversify your portfolio and offer upside potential when inflation is on the rise. Of course, diversification does not ensure against loss.

Protecting your wealth

The bottom line for inflation: It can impact your returns today in ways that can impact your quality of life tomorrow. If you have concerns about how inflation may affect your financial goals and whether your investments are outpacing inflation, discuss your options with your investment professional.

It's entirely possible you already have inflation hedges playing their part. But a straightforward conversation with your financial advisor can offer peace of mind — and possibly lead to a more enduring strategy for protecting your wealth in all economies.