The earliest recorded inflation-indexed bonds were issued by the Commonwealth of Massachusetts in 1780 during the Revolutionary War. Much later, emerging market countries began issuing ILBs in the 1960s. In the 1980s, the UK was the first major developed market to introduce “linkers” to the market.

Several other countries followed, including Australia, Canada, Mexico and Sweden. In January 1997, the U.S. began issuing Treasury Inflation-Protected Securities (TIPS), now the largest component of the global ILB market.

Today inflation-linked bonds are typically sold by governments in an effort to reduce borrowing costs and broaden their investor base. Corporations have occasionally issued inflation-linked bonds for the same reasons, but the total amount has been relatively small.

• What Are Good Hedges Against Inflation?
• How do You Value Inflation-Linked Bonds?
• What Should I Invest in During Hyperinflation?
• What Happens to Bonds With Inflation?
• Inflation-linked Bonds South Africa
• How to Buy Inflation-linked Bonds
• Inflation-linked Bonds UK
• Inflation-linked Bonds Pricing
• Inflation-linked Bonds ETF
• Inflation-linked Bonds Australia
• Inflation-linked Bonds RBI
• Inflation-linked Bonds Canada
• Is Gold a Good Hedge Against Inflation?
• Is Oil a Good Inflation Hedge?
• Are Bonds a Good Hedge Against Inflation?
• What Investment is Best During Inflation?
• How do You Value Inflation-Linked Bonds?
• How do Individuals Hedge Against Inflation?
• Inflation-Indexed Bonds India
• Inflation-Indexed Bonds Definition
• What Sectors do Well in Inflation?
• What Happens to Bonds When Inflation Rises?
• What Happens to Bond Prices During Inflation?
• Do REITs Protect Against Inflation?
• How Can You Protect Yourself From Inflation?
• How do You Hedge Against a Market Crash?
• What Are The 4 Types of Bonds?

What Are Good Hedges Against Inflation?

If you expect inflation to rise, it can actually be a good time to be a borrower, if you can avoid being directly exposed to that inflation. The reason? If you borrow at a fixed interest rate, you’re effectively repaying your debt with cheaper dollars in the future. It can get even better if you’re using certain types of debt to invest in assets that are likely to appreciate over time, such as real estate.

Here are some top inflation hedges that may help you mitigate the impact of inflation.

1. TIPS

TIPS, or Treasury inflation-protected securities, are a useful way to protect your investment in government bonds if you expect inflation to speed up. These U.S. government bonds are indexed to inflation, so if inflation moves up (or down), the effective interest rate paid on TIPS will too.

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TIPS bonds pay interest every six months, and they’re issued in maturities of 5, 10 and 30 years. Because they’re backed by the U.S. federal government (like other government debt), they’re considered among the safest investments in the world.

2. Floating-rate bonds

Bonds usually offer a fixed payment for the life of the bond, meaning bonds have their broad side exposed to rises in inflation. One way to mitigate that effect, however, is with a floating rate bond, where the payout rises in response to upticks in interest rates caused by rising inflation.

One way to buy these is through ETFs or mutual funds, which typically own a wide assortment of such bonds. So in addition to inflation protection, you’ll also get some diversification, meaning your portfolio may benefit from lower risk.

3. A house

You might not think of a house as a good way to hedge against inflation, but if you use a mortgage to buy your house, it can be an excellent way to do so. With a long-term mortgage – at close to historically low rates – you’ll lock in cheap funding for up to three decades.

A fixed-rate mortgage allows you to maintain the biggest portion of housing expenses at the same payment. Sure, property taxes will rise and other expenses may creep up, but your monthly housing payment remains the same. That’s certainly not the case if you’re renting.

And, of course, by owning a home you’ll have the potential for its value to increase over time. If more money is flooding the market, you can get price appreciation, too.

4. Stocks

Stocks are a good long-term vehicle for hedging against inflation, even if they may get hit by anxious investors in the short term as their worries rise. But not all stocks are equally good inflation hedges. You’ll want to look for companies that have pricing power, so that as their own costs rise, they can raise prices on their customers or even charge more for their goods.

And as a company’s profits grow over time, its stock price should climb. While the stock market might get hit by worries of inflation, the best companies power through it with their better economics.

5. Gold

Gold has traditionally been a safe-haven asset for investors when inflation revs up or interest rates are very low. Gold tends to fare well when real interest rates – that is, the reported rate of interest minus the inflation rate – go into negative territory. Investors often view gold as a store of value during tough economic times, and it has succeeded in this purpose over long periods.

One good option for investing in gold is to buy it through an ETF, so you won’t have to actually own and protect the gold yourself. Plus, you have several options with ETFs, allowing you to own physical gold or the stocks of gold miners, which can offer higher upside if gold prices soar.

How do You Value Inflation-Linked Bonds?

At a continuous inflation rate of 2% over two years, €1.00 is worth €1.04 two years later. As with an ordinary bond, the investment is made at purchase, none of this inflation uptick is being transferred into our investments.

At maturity, this means that, due to inflation, the monetary value of a €1,000 investment would only be able to purchase goods and services of the amount of €961.17 – the higher the inflation rate and the longer the investment horizon, the more inflation will erode your purchasing power at maturity of the bond.

To consider the attractiveness of an investment in inflation-linked bonds, investors like to compare the bonds with the conventional (or nominal) bonds of the same issuer. The interest rate of a nominal bond is listed on the face of a bond, this is also known as the nominal yield of a bond.

The real yield of a bond refers to the nominal yield minus the rate of inflation. This means that, while the yield listed on your bond might say your interest is 3% (nominal yield), if inflation is 2% you are effectively only receiving 1% of real yield.

Another important measure is the rate of breakeven inflation. This relates to the difference between the nominal yield of a nominal bond and that of an indexed bond with equivalent maturity issued by the same government.

As already mentioned, the nominal yield of an inflation-linked bond is often lower than that of a nominal bond, as an additional amount of interest is related to the inflation rate. By calculating breakeven inflation, investors receive an inflation rate that must be achieved over the life of a bond, in order that the indexed bond equals the nominal bond.

What Should I Invest in During Hyperinflation?

There are no guarantees when it comes to investing for inflation. At best, certain investments may be inflation-safe, but returns can never be guaranteed. This is especially true in the rapidly evolving coronavirus-driven financial environment we’re now in. Certainly, if employment continues to decline — and consumption with it — a deflationary trend will prevail.

While it’s possible most of the stimulus will find its way into the financial markets and raise asset prices, enough of it can move into consumers’ pockets to reverse the deflationary trend of the past 40 years. We also can’t discount the possibility investors will be hesitant to quickly reenter the financial markets if the current downturn gets much worse.

1. Keep Cash in Money Market Funds or TIPS

If you suspect that inflation will be a factor in the future, it’s best to keep any cash-type investments in money market funds or a high-interest cash account like Unifimoney.

While it’s true that money market funds currently pay next to nothing, they’re the cash investment of choice during periods of rising inflation.

Here are two reasons why this is true:

1. Because the rates they pay fluctuate continuously with interest rates, and they automatically adjust upwards as interest rates rise. There’s no need to chase higher-yielding cash-type investments.
2. Since money market interest rates rise with the general market, you won’t have to face the loss of market value that plagues fixed-rate investments during times of inflation.

When inflation hits, money market funds are interest-bearing investments, and that’s where you need to have your cash parked.

Still another alternative is Treasury Inflation-Protected Securities, or TIPS, issued by the U.S. Treasury. You can buy these online through Treasury Direct in denominations as small as $100.

TIPS are actually quite complicated. Here are the basics of TIPS:

• They can be purchased in multiples of $100.
• Available terms are 5-, 10- and 30-years, which means they’re longer-term securities.
• TIPs pay regular interest and make annual adjustments — up or down — to the principal, based on the direction of the Consumer Price Index (CPI).
• If the CPI drops, your principal will be reduced, but TIPs held to maturity will pay at least their face value.
• Both interest and any increase in the principal are taxable in the year paid.
• Neither interest nor principal increases are taxable at the state and local level.
• Unlike the other asset classes on this list, TIPs aren’t likely to produce big gains in an inflationary environment. But they provide some inflation-adjusted stability to your portfolio.

The bonds are available in terms of five, 10, and 30 years, and pay interest twice annually. And each year the value is adjusted based on the Consumer Price Index (CPI). This gives you regular interest income, plus an annual adjustment for inflation to your principal value.

2. Inflation Is Usually Kind to Real Estate

Over the long term, real estate is also usually an excellent investment response to inflation. Real estate is actually the ultimate hard asset and often sees its greatest price appreciation during periods of high inflation. This is especially true because, as rents rise, people become increasingly interested in owning as a way of getting the tax benefits that help offset the general level of inflation.

You can invest directly in individual properties — residential or commercial — but you can also invest in REIT (real estate investment trusts) like the Equity Residential (EQR) trust. This trust has more than 300 large apartment complexes, primarily in high-cost markets like New York, Boston, San Francisco, Southern California, Washington, D.C., and Seattle.  

If you want crowdfunding platforms that offer REITs, Streitwise is our pick. This platform gives the opportunity for almost anyone to invest in private real estate deals with a low minimum investment of just $1,000.

However you handle it, real estate should have a place in your portfolio if you anticipate rising inflation.

3. Avoid Long-Term Fixed-Income Investments

The worst investment to put money into, during periods of inflation, are long-term fixed-rate interest-bearing investments. These can include any interest-bearing debt securities that pay fixed rates, but especially those with maturities of 10 years or longer.

The problem with long-term fixed-income investments is that when interest rates rise, the value of the underlying security falls as investors flee the security in favor of higher-yielding alternatives.

That 30-year bond that’s paying 3% could decline in value by as much as 40%, should interest rates on newly issued 30-year bonds rise to 5%.

Long-term fixed-income investments are excellent when inflation and interest rates are falling. But if you believe that inflation is about to take off, you’d be better off moving your money out of long-term fixed-income investments and into shorter-term alternatives, particularly money market funds.

4. Emphasize Growth in Equity Investments

Many investors try to balance out their equity portfolios by investing in high dividend-paying stocks, or in growth and income funds, and this can work especially well during periods of price stability. But when inflation accelerates, it can hurt your investment returns.

This is at least in part because high dividend-paying stocks are negatively affected by rising inflation in much the same way long-term bonds are.

The better alternative is to invest primarily in growth-type stocks and funds. You should also emphasize sectors that are likely to benefit from inflation. These can include:

• Energy
• Food
• Healthcare
• Building materials
• Technology

Since all are likely to rise in price with inflation, they’re likely to perform better than other equity sectors.

You can invest in these sectors through an ETF fund or you can buy specific stocks that have growth potential. For example, you can invest in energy stocks through the S&P Oil & Gas Exploration & Production ETF (XOP) or Vanguard’s Health Care Index Fund (VHT). Once you have identified what you want to buy, you can purchase it through a broker E*TRADE.

5. Commodities Tend to Shine During Periods of Inflation

While there isn’t an exact correlation between price levels and commodities, certain hard assets have traditionally been favored by inflation. Precious metals, particularly gold and silver, come to mind immediately. You can hold precious metals in a direct form, with coins or bullion bars, but you can also invest indirectly through ETFs that hold actual gold.

You can also invest in gold mining stocks, or in funds comprised of these stocks. However, these are stocks, and not the actual metal itself. They also tend to be extremely volatile, even during times when gold prices are rising.

A more predictable hold on the stock side will likely be energy stocks and funds. This is especially important since rising energy prices are often one of the primary drivers in inflationary environments.

If you want to invest in commodities, we recommend opening a brokerage account at one of our top-rated brokers. Once you have an account open, you can trade directly through most full-service brokerage firms via a futures fund, options, or an ETF.

6. Convert Adjustable-Rate Debt to Fixed-Rate

Technically speaking, this is not actually an investment move, but it could be one of the most profitable strategies you can make in response to rising inflation.

Periods of low or declining inflation favor adjustable rates over fixed rates when you borrow money. But the dynamic reverses when inflation rises. Higher inflation results in higher interest rates, which means that as inflation accelerates, your adjustable rates will continue to rise — even to potentially unsustainable levels.

If you believe inflation is coming, you should begin rolling your adjustable-rate debt over to fixed rates. This should include credit cards, home equity lines of credit, and especially your first mortgage if it happens to be an ARM.

Talk to your loan provider to see what options are available. It’s a good idea to also check the paperwork on your loan to see when your rates will increase so you can plan. If you refinance your mortgage, try to lower the repayment period and avoid resetting your 30-year mortgage. You will end up paying a lot less in interest, even if your monthly payments remain the same or are higher.

What Happens to Bonds With Inflation?

A bond is a fixed-income security. Bonds allow governments and companies to sell some of their debt to investors. Bonds that offer a fixed interest rate are exposed to interest rate risk. If you buy bonds, it’s best to know how interest rates could affect your investment.

Inflation is the rising level of prices for goods and services. It can have two negative impacts on those who invest in bonds. One is obvious, while the other is more subtle. To invest wisely, you should learn about both.

In short, inflation makes interest rates go up. This in turn makes bond values go down. But the full picture is more complex.

The Federal Reserve (the Fed) is the United States’ central bank. It sets the country’s monetary policy and manages inflation. When inflation rises, the Fed may choose to raise short-term interest rates. The goal is to reduce the demand for credit and help prevent the economy from overheating.

When the Fed raises short-term rates—or when it is expected to do so in the future—intermediate and longer-term rates also tend to go up. Since bond prices and yields move in opposite directions, rising yields mean falling prices. This means a lower value for your fixed-income investment.

The second impact of inflation is less obvious. But, it can take a major bite out of your portfolio returns. This effect is the difference between the “nominal” return and the “real” return. The nominal return is what a bond or bond fund provides on paper. The real return is adjusted for inflation.

Nominal Return – Inflation = Real Return

To understand this concept, think of a shopping cart of food that you buy at the supermarket. If the items in the cart cost $100 this year, inflation of 3% means that the same group of items cost $103 a year later.

Let’s say that during that same year, you have a short-term bond fund with a yield of 1%. Over the year, the value of a $100 investment rises to $101 before taxes. On paper, you made 1%. But in real-world money, they actually lost $2 worth of purchasing power. The “real” return was –2%.

The average rate of inflation in the United States since 1913 has been 3.2%. This is skewed somewhat by the high-inflation periods of World War I, World War II, and the 1970s. But, it still means that investors needed to earn an average annual return of 3.2% just to stay even with inflation.4

Keep in mind that inflation compounds each year, just like investment returns. But with inflation, the result is negative. From 1982 through the present, inflation has risen nearly 100% on a cumulative basis due to this compounding effect. As a result, you would have needed to see the value of your investments double during that time just to keep up with inflation.

Inflation-linked Bonds South Africa

Inflation-linked bonds (ILBs) are essentially loans where the principal and interest payments are contractually linked to an inflation measure. In South Africa this is the consumer price index (CPI). Governments are the primary issuers of ILBs around the world.

Although they were first issued in Massachusetts in the 1780s, the modern ILB market only really began in the 1980s when the UK government first started selling them on any scale. The South African government, meanwhile, began issuing ILBs in 2000. Today they are widely traded, with US Treasury Inflation-Protected Securities (TIPS) making up the largest portion of the global ILB market.

The structure of ILBs means that they provide investors protection against rising inflation over time. They work by regularly adjusting the principal amount invested by an investor by the latest CPI rate, so their principal value rises over time (or can decrease in a deflationary environment, although this is rare). At the same time, the investor receives a regular coupon payment (the interest).

Although the interest rate stays fixed, because the interest is paid on the rising inflation-adjusted principal value, the rand value of the interest paid also rises over time, effectively also linking the coupon to inflation.

Once an ILB is issued and listed on the JSE, its value moves up and down in response to changing market conditions and sentiment, just like any listed security. Not surprisingly, its price is sensitive to changes in the inflation and interest rates (among other factors).

Thus, when real yields rise, the price of the ILB will go down and vice-versa. This is how ILB returns can suffer during low-inflation, slow-growth conditions. Besides offering protection against inflation, ILBs also serve as an excellent diversifier in a multi-asset portfolio due to their low correlation to other asset classes.

When we look at the movement of ILBs compared to local equity, listed property and even nominal bonds, we find that they exhibit a low tendency to move in the same direction as these other asset classes. Therefore, they would typically lower the overall volatility of portfolio returns.

How to Buy Inflation-linked Bonds

Treasury Inflation Protected Securities are bonds whose principal value is adjusted based on changes in the Consumer Price Index. TIPS differ from I bonds in that the interest rate doesn’t vary.

Instead, the semi-annual interest payment is inflation-adjusted by applying the TIPS stated interest rate when it was issued to a principal value that increases or decreases based on changes in the rate of inflation as measured by the Consumer Price Index.

Purchasing Individual TIPS

TIPS can be bought directly at U.S. Treasury auctions or in the secondary market using a brokerage account. The secondary market has TIPS that were previously issued and have had their principal values adjusted based on the index ratio.

Investors can invest in new TIPS when they are auctioned on the TreasuryDirect website. When buying from TreasuryDirect, the investor makes a non-competitive bid. That means the investor will receive the desired amount at the interest rate that is set through the auction process.

The market price of TIPS in the secondary market will differ from the adjusted principal amount if interest rates have changed. If prevailing interest rates are higher than the stated interest on the TIPS, then the value of the TIPS will be less than the adjusted principal value. 

If prevailing interest rates are lower than the stated interest rate on the TIPS, then the value of the TIPS will be higher than the adjusted principal amount.

Market prices for TIPS change so that the yield-to-maturity on the TIPS reflects prevailing interest rates. The yield-to-maturity is the estimated annualized return if a bond is held until it matures. 

Suppose, for example, a new 5-year TIPS is auctioned at a 0.5% interest rate. Suppose there is also a 10-year TIPS that was issued at a 1% interest rate five years ago that now has five more years until it matures.

In that situation, the price of the original 10-year TIPS needs to rise so that its yield-to-maturity is closer to 0.5%. That way, the investor would be somewhat indifferent between purchasing the newly issued 5-year TIPS compared to buying a TIPS that has five years until it matures.

In all likelihood, in this example, the TIPS trading in the secondary market would yield a little more than the newly issued TIPS. The reason is the existing TIPS would have an adjusted principal balance that could decline if there was a period of deflation. That could lead to a potential loss for investors, depending on the price they paid for the TIPS.

Whereas, a purchaser of a newly issued 5-year TIPS would not lose money if the bond is held to maturity even if the Consumer Price Index falls for five consecutive years because the investor would receive the TIPS’ original face value. 

How To Purchase An Individual TIPS Through An Online Brokers

Most online brokerages list out individual TIPS that investors can purchase in the secondary market. The TIPS listing will include several pieces of information that are critical to evaluating the Treasury Inflation Protected Security.

Here are the key pieces of information in making a purchase decision on an individual Treasury Inflation Protected Security in the secondary market using an online brokerage account. Each broker has a different format for presenting this information so you will need to review the specific broker’s glossary of terms and explanations.

Coupon

The stated fixed interest used to calculate the bond’s semi-annual interest rate.

Maturity

The date when the TIPS matures and investors will receive the higher of the adjusted principal balance or the face value.

Yield-to-maturity

This is the estimated annualized return for holding the bond until it matures, assuming that inflation doesn’t change. In other words, the yield-to-maturity doesn’t reflect an inflation adjustment because it is unknown what that will be in the future. The TIPS yield-to-maturity is also known as a real rate of return.

Break-even Inflation Rate

Investors can compare the yield-to-maturity on TIPS to the yield-to-maturity on a regular Treasury bonds that are not indexed for inflation. The yield-to-maturity on non-inflation indexed Treasuries is known as the nominal yield. The difference between the nominal Treasury yield-to-maturity and the TIPS yield-to-maturity is known as the break-even inflation rate.

It reflects market participants’ expectations for future inflation. The break-even inflation rate is not listed on the broker’s website and will need to be calculated by comparing the yield-to-maturity on the TIPS to the yield-to-maturity on a Treasury bond with the same maturity.

For example, suppose a 5-year TIPS has a yield to maturity of 0.5%, and a 5-year Treasury bond has a yield to maturity of 1.5%. The difference in yield is 1%, which is the break-even inflation rate. If over the next five years, inflation comes in higher, than 1% annually than the investor in the Treasury Inflation Protected Security will make more than holding the regular 5-year Treasury.

The reason the TIPS is more profitable in this example is the total cash flows received in the form of interest payments and the adjusted principal value is greater than the cash flows received on the Treasury bond.

Price

The price listed is the amount asked for the bond. The price is in the form of a factor, such as 1.05 or .98. The price factor is multiplied by the face value in order to estimate the total cost of the TIPS. The price asked can be compared with the index ratio or inflation factor for the specific bond to see if the total cost is greater or less than the adjusted principal value. 

Inflation Factor or Index Ratio

Some brokerage firms will show the inflation factor or index ratio used to calculate the adjusted principal balance. If it is not listed, the investor can look up the index ratio on TreasuryDirect by using the bond’s unique CUSIP number listed on the broker’s website.

Accrued Interest

Accrued interest reflects interest due to the current TIPS holder for the time period between the last interest payment and the date of the price quote. Sometimes a broker will reflect the accrued interest in the price and designate it the adjusted price.

Estimated Total

This reflects the estimate of the total cost to purchase the TIPS, including the accrued interest. The estimated total is calculated by multiplying the original face value by the asking price factor and adding the accrued interest.

For some brokers, the estimated total is calculated by multiplying the adjusted price factor by the original face value amount the investor wants to purchase. The adjusted price factor takes into account accrued interest.

Inflation-linked Bonds UK

Global inflation has been falling since the early 1990s. Over the last decade in the UK, the Consumer Prices Index (CPI) has been between two and three percent, which is broadly in line with the Bank of England’s inflation target. Yet even at a relatively low rate of 2.5%, a basket of goods and services that cost £100 ten years ago would cost £128 today.

The effect of inflation on investment returns can be just as destructive. Assume a hypothetical equity portfolio return of 4% per year and an inflation rate of 2.5%. The real return of this portfolio, or the return minus the rate of inflation, would be 1.5%.

So, in this case, an investment in equities would increase investors’ purchasing power by only 1.5% a year. An investment in a GBP money market fund, savings account or any other investment returning less than the 2.5% rate of inflation would effectively erode purchasing power, defeating even the most conservative goal of maintaining quality of life.

Inflation-linked bonds are designed to help protect investors from the negative impact of inflation by contractually linking the bonds’ principal and interest payments to a nationally recognized inflation measure such as the Retail Price Index (RPI) in the UK, the European Harmonised Index of Consumer Prices (HICP) ex-tobacco in Europe, and the Consumer Price Index (CPI) in the U.S.

The earliest recorded inflation-indexed bonds were issued by the Commonwealth of Massachusetts in 1780 during the Revolutionary War. Much later, emerging market countries began issuing ILBs in the 1960s. In the 1980s, the UK was the first major developed market to introduce “linkers” to the market.

Several other countries followed, including Australia, Canada, Mexico and Sweden. In January 1997, the U.S. began issuing Treasury Inflation-Protected Securities (TIPS), now the largest component of the global ILB market.

Today inflation-linked bonds are typically sold by governments in an effort to reduce borrowing costs and broaden their investor base. Corporations have occasionally issued inflation-linked bonds for the same reasons, but the total amount has been relatively small.

Inflation-linked Bonds Pricing

A bond investor holds a bond with a fixed interest rate. The interest payments, known as coupons, are usually paid semi-annually and represent the bondholder’s return on investing in the bond. However, as time goes by, inflation also increases, thereby, eroding the value of the investor’s annual return.

This is unlike returns on equity and property, in which dividend and rental income increase with inflation. To mitigate the impact of inflation, index-linked bonds are issued by the government.

An index-linked bond is a bond which has its coupon payments adjusted for inflation by linking the payments to some inflation indicator, such as the Consumer Price Index (CPI) or Retail Price Index (RPI).

These interest-bearing investments typically pay investors a real yield plus accrued inflation, providing a hedge against inflation. The yield, payment, and principal amount are calculated in real terms, not nominal numbers. One can think of the CPI as the exchange rate that converts the return on a bond investment to a real return.

An indexed-linked bond is valuable to investors because the real value of the bond is known from purchase and the risk involved with uncertainty is eliminated. These bonds are also less volatile than nominal bonds and help investors maintain their purchasing power.

Consider two investors—one purchases a regular bond and another buys an index-linked bond. Both bonds are issued and purchased for $100 during July 2019, having the same terms—4% coupon rate, 1 year to maturity, and $100 face value. The CPI level at the time of issuance is 204.

The regular bond pays an annual interest of 4%, or $4 ($100 x 4%), and the principal amount of $100 is repaid at maturity. At maturity, the principal and the interest payment due, that is, $100 + $4 = $104, will be credited to the bondholder.

Assuming the CPI level in July 2020 is 207, the interest and principal value must be adjusted for inflation with the index-linked bond. Coupon payments are calculated using an inflation-adjusted principal amount, and an indexation factor is used to determine the inflation-adjusted principal amount.

For a given date, the indexation factor is defined as the CPI value for the given date divided by the CPI at the original issue date of the bond. The indexation factor in our example is 1.0147 (207/204). Therefore, the inflation rate is 1.47%, and the bondholder will receive $105.53 ($104 x 1.0147) when it matures.

The annual interest rate on the bond is 5.53% [(($105.53 – $100)/$100) x 100%]. The investor’s approximate real return rate is 4.06% (5.53% – 1.47%), calculated as the nominal rate less the inflation rate. 

Inflation-linked Bonds ETF

Exchange-traded funds (ETFs) that invest in U.S. Treasury inflation-protected securities (TIPS) present a convenient way for investors to gain exposure to these government-guaranteed fixed-income instruments.

TIPS are Treasury securities indexed to inflation, meaning that when inflation rises, so too does the principal amount of the security and the associated interest payments. TIPS spread is an important related metric that shows the difference in yield between TIPS and regular U.S. Treasury securities with the same maturity.

This shows how much people are willing to pay for inflation protection and also indicates how much inflation investors anticipate. The 10-year TIPS spread as of May 18, 2021 is 2.52%. This means that 10-year TIPS have a yield 2.52% lower than the 10-year Treasury, so inflation would need to average 2.52% per year for the two to have the same returns.

TIPS funds currently are experiencing rising inflows as accelerating price increases spark investor fears about inflation amid the economy’s ongoing recovery. TIPS ETFs enable investors to safeguard the value of their portfolios by mitigating against the erosion of purchasing power caused by inflation.

There are 14 distinct TIPS ETFs that trade in the U.S., excluding inverse and leveraged ETFs, as well as funds with less than $50 million in assets under management (AUM).

TIPS, as measured by the Bloomberg Barclays US TIPS (Series-L) Index, have significantly underperformed the broader market with a total return of 7.4% over the past 12 months compared to the S&P 500’s total return of 42.0%, as of May 18, 2021.

The best-performing TIPS ETF, based on performance over the past year, is the SPDR FTSE International Government Inflation-Protected Bond ETF (WIP).

Inflation-linked Bonds Australia

Inflation linked bonds (ILBs) are simply bonds that have returns or cashflows linked to inflation. They are securities whose return includes a component that is determined by the future level of a pre-determined index, for example the Consumer Price Index (CPI) or inflation.

For example, if inflation is rising, then the capital value of the ILB will rise directly in line with the headline CPI. So, as the CPI rises and falls, so too will the capital value of the bonds.

There are two main types of ILBs issued in Australia, capital indexed bonds (CIB) and indexed annuity bonds (IAB).

As the names suggests, ILBs are particularly well suited to investors concerned with the effect inflation will have on their investment portfolio. ILBs are the only investment that offers a true, direct protection against rises in inflation because the returns are linked to the CPI.

Inflation-linked Bonds RBI

The United States, India, Canada, and a wide range of other countries issue inflation-linked bonds. Because they reduce uncertainty, inflation-indexed bonds are a popular long-range planning investment vehicle for individuals and institutions alike.

Inflation-linked bonds are tied to the costs of consumer goods as measured by an inflation index, such as the consumer price index (CPI). Each country has its own method for calculating those costs on a regular basis. In addition, each nation has its own agency responsible for issuing inflation-linked bonds.

In the United States, Treasury Inflation-Protected Securities (TIPS) and inflation-indexed savings bonds (I bonds) are tied to the value of the U.S. CPI and sold by the U.S. Treasury.

In the United Kingdom, inflation-linked gilts are issued by the U.K. Debt Management Office and linked to that country’s retail price index (RPI). The Bank of Canada issues that nation’s real return bonds, while Indian inflation-indexed bonds are issued through the Reserve Bank of India (RBI).

Inflation-linked Bonds Canada

Inflation in Canada and in the U.S. remains muted, and interest rates remain near historical lows. Still, inflation can bite fixed-income investors. If, for example, you have fixed income investments yielding 4 per cent, and inflation runs at 2 per cent on average, your real return is 2 per cent (4-2%).

But there are things you can do to hedge the effects of inflation or even make inflation a friend. One popular investment vehicle is called inflation-linked bonds (ILBs).

Returns on inflation-protected bonds are pegged to the cost of consumer goods, such as the consumer price index (CPI). That means the principal of the bond and interest payments rise with inflation, cushioning its impacts on your investment.

Say, for instance, you decided to purchase an ILB issued at $1,000 with a fixed annual coupon of 5 per cent. If the inflation rate remains unchanged, the bond will pay you interest of $50 every year.

However, if the CPI rises 2 per cent, the principal will then be adjusted to $1,020, and the annual coupon payment you receive will increase to $51. When the bond matures, its principal will be adjusted for inflation.

What this means is that ILBs can preserve your purchasing power and thus overcome one of the biggest drawbacks of traditional bonds.

ILBs are typically issued by sovereign governments, and each country terms them differently. In the U.S., they are called Treasury Inflation-Protected Securities (TIPS) and are linked to the country’s CPI. In Canada, the central bank issues Real Return Bonds (RRBs) and ties them to the All-items CPI.

But ILBs are more than just a tool to hedge against rising prices. Despite being classified as fixed income, ILBs are considered a separate asset class from equities and traditional bonds. That’s because their returns don’t correlate with those of stocks or other fixed income assets, making them good picks for diversification and for mitigating volatility.

Is Gold a Good Hedge Against Inflation?

Rightly or not, gold is widely viewed as an inflation hedge—a reliable measure of protection against purchasing power risk. The precious metal may not be the best option for that purpose, though. Some gold investors fail to consider its volatility as well as its opportunity cost, while others fail to anticipate storage needs and other logistical complexities of gold ownership.

For these and other reasons, some view U.S. Treasury bills as a superior safe-haven alternative to gold. Both asset classes have their own sets of pros and cons; here’s a look at them.

Like any other investment, gold fluctuates in price. Investors may have to wait long stretches to realize profits, and research shows that the majority of investors enter when gold is near a peak, meaning upside is limited and the downside is more likely.

Meanwhile, slow but steady Treasuries provide less excitement but reliable income. The longer the gold is held over Treasuries, the more painful these opportunity costs can also become, due to sacrificed compound interest.

An arguably lesser but no-less present worry: some gold investors also must contend with the chore of safely storing their investment by vaulting it at home or by acquiring a safe deposit box at the bank. But in either scenario, bullion coins that are held for one year or longer are classified as “collectibles”—similar to artwork, rare stamps, or antique furniture.

Whether the precious metal is in the form of an American Eagle gold coin, a Canadian Gold Maple Leaf coin, or a South African Krugerrand, its sale automatically triggers a long-term federal capital gains tax rate of approximately 28%—nearly double the 15% capital gains rate for typical stocks.

All of that said, gold has fared better than silver, platinum, palladium recently, as well as most other precious metals. In 2020, the price of gold jumped 28% percent. Gold’s price has always fluctuated, like any other investment. However, in light of this trajectory, many believe gold’s future performance is uncertain, and favor a shift to Treasuries.

Is Oil a Good Inflation Hedge?

Generally, Gold is considered as the ultimate hedge against inflation. However, we suggest keeping a close eye on Silver. If history is anything to go by, then Oil’s performance as a tell-tale sign for what Silver might do next.

Silver and Oil prices have a very tight correlations during multi-year periods of boom, known as supercycles.

The previous two supercycles took place in the 1970s and the 2000s. In both cases, Silver prices tracked Oil prices identically and that trend is expected to re-emerge again – during the current commodities supercycle, which is just getting started.

During its last secular bull run in the 2000s – Oil prices rallied nearly 630%. But with a staggering gain of nearly 1150%, Silver solidly outperformed Oil before their parallel bull markets ultimately ran their course.

Today crude oil is up over 264% from the lows seen in April 2020, whilst Silver is only up 57%, during the same period. Even if Oil was to stop its advance right here in a secular sense, which I believe is extremely unlikely, then Silver still has massive upside potential from current levels.

Are Bonds a Good Hedge Against Inflation?

A 60/40 stock/bond portfolio is considered to be a safe, traditional mix of stocks and bonds in a conservative portfolio. If you don’t want to do the work on your own and you’re reluctant to pay an investment advisor to assemble such a portfolio, consider investing in Dimensional DFA Global Allocation 60/40 Portfolio (I) (DGSIX).

Net Assets 4/13/2020	$3.5 billion
Expense Ratio	0.25%
Average Daily Trading Volume	N/A
5-Year Trailing Returns	2.25%

A 60/40 stock/bond portfolio is a straightforward, easy investment strategy. But like all investment plans, it does have some disadvantages. Compared to an all-equity portfolio, a 60/40 portfolio will underperform over the long term. Additionally, over very long time periods, a 60/40 portfolio may significantly underperform an all-equity portfolio because of the effects of compounding interest.

It’s important to keep in mind that a 60/40 portfolio will help you hedge against inflation (and keep you safer), but you’ll likely be missing out on returns compared to a portfolio with a higher percentage of stocks.

What Investment is Best During Inflation?

For consumers, inflation can mean stretching a static paycheck even further, but for investors, inflation can mean continued profit as they add to their retirement portfolio.

Real Estate

Real estate is a popular choice not only because rising prices increase the resale value of the property over time, but because real estate can also be used to generate rental income. Just as the value of the property rises with inflation, the amount tenants pay in rent can increase over time.

These increases let the owner generate income through an investment property and helps them keep pace with the general rise in prices across the economy. Real estate investment includes direct ownership of property and indirect investment in securities, like a real estate investment trust (REIT).

Commodities

When a currency is having problems—as it does when inflation climbs and decreases its buying power—investors might also turn to tangible assets.

For centuries, the leading haven has been gold—and, to a lesser extent, other precious metals. Investors tend to go for gold during inflationary times, causing its price to rise on global markets. Gold can also be purchased directly or indirectly.

You can put a box of bullion or coins under your bed if a direct purchase suits your fancy, or you can invest in the stock of a company involved in the gold mining business. You can also opt to invest in a mutual fund or exchange-traded fund (ETF) that specializes in gold.

Commodities include items like oil, cotton, soybeans, and orange juice. Like gold, the price of oil moves with inflation. This cost increase flows through to the price of gasoline and then to the price of every consumer good transported by or produced.

Agricultural produce and raw materials are affected as well as automobiles. Since modern society cannot function without fuel to move vehicles, oil has a strong appeal to investors when prices are rising.

Other commodities also tend to increase in price when inflation rises. Some more advanced investors may wish to trade in commodities futures. However, all investors may gain exposure through a publicly traded partnership (PTP) that gains exposure to commodities through the use of futures contracts and swaps.

Bonds

Investing in bonds may seem counterintuitive as inflation is deadly to any fixed-income instrument because it often causes interest rates to rise. However, to overcome this obstacle, investors can purchase inflation-indexed bonds. In the United States, Treasury Inflation-Protected Securities (TIPS) are a popular option. pegged to the Consumer Price Index.

When the CPI rises, so does the value of a TIPS investment. Not only does the base value increase but, since the interest paid is based on the base value, the amount of the interest payments rises with the base value increase. Other varieties of inflation-indexed bonds are also available, including those issued by other countries.

Inflation-indexed bonds can be accessed in a variety of ways. Direct investment in TIPS, for instance, can be made through the U.S. Treasury or via a brokerage account. They are also held in some mutual funds and exchange-traded funds. For a more aggressive play, consider junk bonds. High-yield debt—as it’s officially known—tends to gain in value when inflation rises, as investors turn to the higher returns offered by this riskier-than-average fixed-income investment.

Stocks

Stocks have a reasonable chance of keeping pace with inflation—but when it comes to doing so, not all equities are created equal. For example, high-dividend-paying stocks tend to get hammered—like fixed-rate bonds—in inflationary times.7 Investors should focus on companies that can pass their rising product costs to customers, such as those in the consumer staples sector.

Loans/Debt Obligations

Leveraged loans are potential inflation hedges as well. They are a floating-rate instrument, meaning the banks or other lenders can raise the interest rate charged so that the return on investment (ROI) keeps pace with inflation.

Mortgage-backed securities (MBS) and collateralized debt obligations (CDOs)—structured pools of mortgages and consumer loans—respectively, are also an option. Investors do not own the debts themselves but invest in securities whose underlying assets are the loans.

MBSs, CDOs and leveraged loans are sophisticated, somewhat risky (depending on their rating) instruments, often requiring fairly large minimum investments. For most retail investors, the feasible course is to buy a mutual fund or ETF that specializes in these income-generating products.

How do You Value Inflation-Linked Bonds?

To compare Inflation-Linked Bonds with nominal government bonds and determine their relative value, investors can look at the difference between nominal yields and real yields, called the breakeven inflation rate.

The difference indicates the inflation expectations priced into the market; it is the rate differential at which the expected returns of Inflation-Linked Bonds and nominal bonds are equal. If the actual inflation rate over the life of the bond is higher than the breakeven inflation rate, investors would earn a higher return holding ILBs while having lower inflation risk.

If the actual inflation rate is lower than expectations, the nominal bond of the same maturity would garner a higher return, though with higher inflation risk. For example, if a 10-year nominal UK gilt is yielding 2.5% and a 10-year UK inflation-linked bond is yielding 0.25%, then the breakeven inflation rate is 2.25%. If an investor believes the UK inflation rate will be above 2.25% for the next 10 years, then a then an Inflation-Linked Bond would be a more attractive investment.

As with other investments, the price of ILBs can fluctuate, and if real yields rise, the market value of an ILB will fall. Real yields can rise, without a corresponding increase in nominal yields.

If held to maturity, however, the market value fluctuations are irrelevant and an investor receives the par amount. In theory, a period of deflation could reduce this par amount. However, in practice, most ILBs are issued with a deflation floor to mitigate this risk.

How do Individuals Hedge Against Inflation?

A disciplined investor can plan for inflation by cultivating asset classes that outperform the market during inflationary climates. Although traditional bonds are the usual go-to for the income-oriented, they aren’t the only investment that produces a revenue stream.

Here are the top five asset classes to consider when seeking protection from inflation. They range from equities to debt instruments to alternative investments. All are feasible moves for the individual investor to make, though they carry different degrees of risk.

1. Reallocate Money Into Stocks

If inflation returns, it’s generally a punch in the jaw for the bond market, but it could be a shot in the arm for the stock market. Consider reallocating 10% of your portfolio from bonds to equities in order to take advantage of this possible trend.

Buying preferred stocks is another possibility. These liquid issues will pay a higher yield than most types of bonds and may not decline in price as much as bonds when inflation appears.

Utility stocks represent a third alternative, where the price of the stock will rise and fall in a somewhat predictable fashion through the economic cycle and also pay steady dividends.

2. Diversify Internationally

There are several major economies in the world that do not rise and fall in tandem with the U.S. market indices, such as Italy, Australia, and South Korea. Adding stocks from these or other similar countries can help to hedge your portfolio against domestic economic cycles. Bonds from foreign issuers can likewise provide investors with exposure to fixed income that may not drop in price if inflation appears on the home front.

3. Consider Real Estate

Real property often acts as a good inflation hedge, One of the easiest ways to get exposure is through real estate investment trusts (REITs), which own portfolios of commercial, residential, and industrial properties. Providing income through rents and leases, they often pay higher yields than bonds. Another key advantage: Their prices probably won’t be as affected when rates start to rise, because their operating costs are going to remain largely unchanged.

4. Look to TIPS

Treasury inflation-protected securities (TIPS) are designed to increase in value in order to keep pace with inflation. The bonds are linked to the Consumer Price Index and their principal amount is reset according to changes in this index.

TIPS’ yields have dropped in value in the secondary market considerably since 2018.1 They may be a good bargain at this point, as they have not yet priced in the possibility of inflation.

5. Buy Bank Loans

Senior secured bank loans are another good way to earn higher yields while protecting yourself from a price drop if rates start to rise. The prices of these instruments will also rise with rates, as the value of the loans increases when rates start to rise (although there may be a substantial time lag for this). The Lord Abbett Floating Rate Fund (LFRAX) is one good choice for those who seek exposure in this area.

Inflation-Indexed Bonds India

Inflation-linked bonds aim to provide security of capital and protection against inflation. It was introduced by the Reserve Bank with the motive to wean away investors from physical gold.

Till recently, interest earned on bank deposits were negative keeping in the mind the high inflation rate.

Now, with returns on these bonds linked to the wholesale price index, investors can be assured that the returns will beat inflation.

How do these bonds operate?

The principal amount is linked to the inflation rate so that the impact is muted. Any increase or decrease in the inflation rate automatically results in an adjustment in the principal.

Tenure

The bonds come with a 10-year tenure and fixed coupon or interest rate.

Payment of interest:

Interest is payable every six months. To compute the interest rate, current inflation in the economy will be adjusted by an ‘inflation indexation factor’ for every interest payment period.

Periodic coupon payments are paid on the adjusted principal.

To simplify, let’s assume a bond with a principal value Rs. 100 carrying a coupon rate of 8%. If inflation is 10%, then the bondholder is paid an interest on the adjusted principal of Rs. 110, i.e. Rs. 8.80. Similarly, future interest payments will be based on the adjusted principal.

In this way, the bonds provide inflation protection as well capital security. On maturity, the adjusted principal or face value, whichever is higher, will be paid.

Tax benefits

The bonds will not receive any special tax benefits and existing income tax rates will be applicable beyond the prescribed limit.

Is there an option to exit before the term ends?

The instrument will be traded like any other government security, thus giving investors a chance to exit their investments.

Will it be really beneficial?

Since the rate of return is based on wholesale inflation and not as per the higher consumer price inflation, investors will receive negative returns on their investment.

What you need to check?

Before investing, kindly note the initial coupon rate on the bond. A coupon close to the prevalent bank fixed deposit rate would be the best bet. 

Inflation-Indexed Bonds Definition

An inflation-indexed bond is a security that guarantees a return higher than the rate of inflation if it is held to maturity. Inflation-indexed securities link their capital appreciation, or coupon payments, to inflation rates. Investors seeking safe returns with little to no risk will often hold inflation-indexed securities. A common example are Treasury Inflation-Protected bonds, or TIPS.

An inflation-indexed bond is also known as an inflation-linked or a real return security.

Inflation-indexed security has its principal indexed to the Consumer Price Index (CPI), or some other nationally recognized inflation index, on a daily basis. The CPI is the proxy for inflation that measures price changes in a basket of goods and services in the U.S. and is published monthly by the Bureau of Labor Statistics (BLS).

By linking security to inflation, the principal and interest income received by investors are protected from the erosion of inflation. For instance, consider a bond that pays 3% when inflation is 2%. This bond will yield only 1% in real terms, which is unfavorable for any investor living on a fixed income or pension.

Who Benefits From Inflation?

Business/household with high debt

High rates of inflation can make it easier to pay back outstanding debt. Business will be able to increase prices to consumers and use the extra revenue to pay outstanding debts.

• However, if a bank borrowed at a variable mortgage rate from a bank. Then if inflation rises and the bank increase interest rates, this will increase the cost of debt repayments.

Governments with debt

Inflation can make it easier for the government to reduce the real value of its debt (public debt as a % of GDP)

This is especially true if inflation is higher than expected. For example in the 1960s, markets expected low inflation so the government was able to sell government bonds at low rates of interest rates.

However, in the 1970s, inflation was higher than expected – and higher than the bond yield on a government bond. Therefore owners of the bonds saw a fall in the real value of their bond, whilst the government saw a fall in the real value of its debt.

Between 1945 and 1991, the nominal value of government debt rose, but inflation and economic growth helped the value of national debt to fall as a percentage of GDP.

Landowners/Owners of physical assets

In a period of hyperinflation, those with savings can see a rapid fall in the real value of their savings. However, those who own physical assets tend to be protected. Physical wealth – such as land, factories and machines will retain their value.

In periods, of hyperinflation, there is often increased demand for assets, such as gold and silver. Gold cannot be subject to the same inflationary pressures as paper money as it cannot be printed.

However, it is worth bearing in mind, that in a period of inflation, buying gold is not guaranteed to increase in real value. This is because the price of gold can also be subject to speculative pressures. For example, the price of gold spiked in 1980 and then fell afterwards.

However, in periods of hyperinflation, holding gold is a way to protect real wealth in a way money is not.

Banks and mortgage companies

In periods of negative real interest rates, it tends to increase profit margins for banks With base rates close to zero and very low saving rates, lending rates are higher than saving rates.

A good example of extreme inflation is Germany in the period 1922-24, the inflation rate reached astronomical figures.

Middle-class workers who had put a lifetime of savings into their pension fund found that in 1924, the pension fund was worthless. After working for 40 years, one middle-class clerk cashed his retirement fund and used it to buy a cup of coffee.

In this hyperinflation, it led to great fear, uncertainty and confusion. People responded by trying to buy anything physical – like buttons, cloth – anything that might hold value better than money.

However, not everyone suffered as much. Farmers did well because the price of food continued to rise. Business who had borrowed large sums found that their debts had effectively disappeared due to inflation reducing the real value of debt. These businesses could buy up over firms who had gone out of business due to the costs of inflation.

Those who owned land or physical assets were able to maintain their wealth.

This kind of very high inflation creates significant grievance as inflation can appear like an unfair way to redistribute wealth from savers to borrowers.

What Sectors do Well in Inflation?

Inflation will help commodity and real estate-related industries, hurt industries that carry high inventories and throw most other sectors into uncertainty. The worst impact of inflation will not be direct as a result of rising prices, but indirectly as the Federal Reserve responds.

Commodity prices rise disproportionately with overall inflation. Look for earnings increases for mining companies. For example, expect a copper mining company to enjoy higher profits.

But processors and fabricators will be whipsawed, paying higher costs, then collecting higher prices, then facing another round of cost increases and another round of raising their own prices. On average, their margins won’t change much, but the timing of cost and revenue changes may make their financials less predictable.

Processors of commodities should also plan on using more working capital. A copper pipe distributor, for example, may move as many pieces of pipe as before the inflation. But if each piece sells for twice last year’s price, then the company needs twice as much working capital for inventory and accounts receivable.

Real estate companies usually benefit from inflation as well. Mortgage costs are most often fixed, while rents will rise with overall inflation, helping property owners.

Although many business managers will grouse about rising costs, the prices they receive will also rise, leaving gross margins little changed. The biggest problem faces companies with large inventories.

Profit for a store, for example, usually reflects the spread between retail and wholesale prices. In an inflationary environment, profit is both the retail-wholesale spread plus also the price increase while holding the inventory. And that higher profit is taxable. But the taxable inflation gains are not real. The company is going to replace the recently sold merchandise with higher-cost goods.

What Happens to Bonds When Inflation Rises?

To understand how interest rates affect a bond’s price, you must understand the concept of yield. While there are several different types of yield calculations, for the purposes of this article, we will use the yield to maturity (YTM) calculation. A bond’s YTM is simply the discount rate that can be used to make the present value of all of a bond’s cash flows equal to its price.

In other words, a bond’s price is the sum of the present value of each cash flow, wherein the present value of each cash flow is calculated using the same discount factor. This discount factor is the yield. When a bond’s yield rises, by definition, its price falls, and when a bond’s yield falls, by definition, its price increases. 

A Bond’s Relative Yield

The maturity or term of a bond largely affects its yield. To understand this statement, you must understand what is known as the yield curve. The yield curve represents the YTM of a class of bonds (in this case, U.S. Treasury bonds).

In most interest rate environments, the longer the term to maturity, the higher the yield will be. This makes intuitive sense because the longer the period of time before cash flow is received, the greater the chance is that the required discount rate (or yield) will move higher. 

Interest rates, bond yields (prices) and inflation expectations correlate with one another. Movements in short-term interest rates, as dictated by a nation’s central bank, will affect different bonds with different terms to maturity differently, depending on the market’s expectations of future levels of inflation.

What Happens to Bond Prices During Inflation?

Keeping your money in short-term bonds is a similar strategy as maintaining cash in a CD or savings account. Your money is safe and accessible.

And if rising inflation leads to higher interest rates, short-term bonds are more resilient whereas long-term bonds will suffer losses. For this reason, it’s best to stick with short- to intermediate-term bonds and avoid anything long-term focused, suggests Lassus.

“Make sure your bonds or bond funds are shorter-term since they will be affected less if interest rates begin to rise quickly,” she says.

“Investors can also reinvest short-term bonds at higher interest rates as bonds mature,” Arnott adds.

Investors have options to protect themselves against inflation, but the safest bet is through TIPS. Otherwise, use an inflation surge period to as a good time to review your overall investment performance and allocation to make sure it aligns with your goals.

“Don’t make dramatic changes based on current inflation or market conditions since most of us are still long-term investors,” Lassus says.

TIPS stands for Treasury Inflation-Protected Securities. While the term may seem like a mouthful, TIPS are actually quite simple to understand.

TIPS are government bonds that mirror the rise and fall of inflation. So, when inflation goes up, the interest rate paid does, too. And when deflation occurs, interest rates fall.

Do REITs Protect Against Inflation?

REITs are companies that own and/or operate properties like shopping malls, office buildings, warehouses and apartment buildings. Although they come with more risk than some other income-producing investments — such as Treasury bonds — they also have inflation protection built into them, experts say.

“Generally, REITs tend to do well in times of inflation, just because of their ability to increase rents and then pass that income on to [shareholders],” said certified financial planner Marco Rimassa, president of CFE Financial in Katy, Texas. 

REITs whose properties strike longer-term lease deals with tenants — for example, retailers at shopping malls — typically have annual increases built in that are based on the movement of the consumer price index. However, those rent hikes also tend to have a limit to how big of a jump can occur, which means inflation could outpace those increases.

Nevertheless, Rimassa said, “even if rent increases are not able to keep pace with inflation in the short term, the property values generally are still increasing.”

The easiest way to get exposure to many REITs at once is through a mutual fund or exchange-traded fund that invests in those real estate companies. From a portfolio share standpoint, about 10% of your stock allocation could go to REITs, Rimassa said.

It’s worth noting that if you hold REITs outside of a tax-advantaged retirement account, their taxation can get tricky. Generally, the dividends are subject to ordinary income tax rates, although you may be able to take a 20% pass-through deduction on some of the income. Because it can be complicated, it’s worth consulting with a tax advisor for guidance.

How Can You Protect Yourself From Inflation?

The U.S. has actually gone through many brief periods of deflation, but in general, economic progress is accompanied by inflationary pressures. Inflation may occur when there is too much money in the system, which leads to an escalation in the price of goods.

Of course, if a household’s two primary sources of wealth creation—asset and income appreciation—rise at a rate equal to or greater than inflation, the negative effects of inflation are neutralized.

Yet, as we’ve seen time and again, that usually is not the case. While the minimum wage has increased, the overall price of goods has outpaced the average salary increases of recent years.

Here are three investment approaches everyone should consider as ways of protecting their hard-earned wealth from the ravages of inflation.

Invest in Stocks

Despite the lack of confidence, most people express about stocks, owning some equities can be a very good way to combat inflation. Think of your household as a business. If a company cannot properly invest its money in projects that will deliver a return above its costs, then it, too, will fall victim to inflation.

The basic premise of business success is that corporations will sell their goods at increasing prices, which will lead to elevated revenues, earnings, and inevitably, stock prices.

Some of the best stocks to own during inflation would be in companies that can increase their prices naturally during inflationary periods. Commodity resource companies are one example. Products like oil, grains, and metals enjoy pricing power during periods of inflation.

The prices of these items tend to go up as opposed to, for example, the price of a computer, which is subject to manufacturer and distributor price adjustments.

Still, price increases aren’t enough to protect against inflation. If a company experiences rising expenses, price increases alone are not enough to maintain equity appreciation. That’s why grocery stores, which may benefit from an increase in food prices, may also suffer from an increase in their cost of goods sold.

Look to invest in businesses such as commodity firms or healthcare companies that possess the strongest profit margins and, generally, the lowest cost of production. Finally, never underestimate the value of dividends during periods of inflation. Dividends increase the total return of a portfolio.

Invest in a Home

When done for the right reasons, like buying a home to live in, real estate is always a good investment. Problems occur when a buyer’s goal is to flip the property they just bought at a profit.

Although experienced real estate investors are able to find hidden values in properties, the average person should focus on purchasing a home with the intent of holding it, even if only for a few years. Real estate investments do not typically generate a return within several months or weeks; they require an extensive waiting period in order for values to increase.

As a home buyer, unless you’re paying cash, you’re likely to put some money down and take out a loan, known as a mortgage, for the remainder of the purchase price. There are different types of mortgages—fixed-rate and adjustable are the most common—but the underlying principle is the same. You pay off a little of the principal each month until you’re left with ownership of a debt-free asset that should continue to appreciate over time.

If you get a fixed-rate mortgage, you end up paying off future debt with cheaper currency if rates increase. But if rates decrease, you’re still responsible for the fixed amount. Various factors should be taken into account in order to determine your best mortgage option.

Like land, home prices tend to increase in value on an average year-over-year basis. It is true that real estate bubbles are usually followed by correctional periods, sometimes causing homes to lose over half of their value. Still, on average, housing prices tend to increase over time, counteracting the effects of inflation.

Invest in Yourself

By far the best investment you can make to be prepared for an uncertain financial future is an investment in yourself. One that will increase your future earning power.

This investment begins with quality education and continues with keeping skills up-to-date and learning new skills that will match those most needed in the not-too-distant future. Being able to stay on top of a business’s changing needs may not only help to inflation-proof your salary, but also recession-proof your career.

How do You Hedge Against a Market Crash?

Every investor lives with the risk, no matter how remote, of a major economic meltdown. It has happened before. It can happen again. If it does, years of hard-earned savings and retirement funds could be wiped out in hours.

Fortunately, there are steps you can take to shield the bulk of your assets from a market crash or even a global economic depression. Preparation and diversification are the key elements of a sound defensive strategy. Together, they can help you weather a financial hurricane.

Diversify

Diversifying your portfolio is probably the single most important measure that you can take to shield your investments from a severe bear market.

Depending on your age and your risk tolerance, it may be reasonable for you to have most of your retirement savings in individual stocks, stock mutual funds, or exchange-traded funds (ETFs).

But you need to be prepared to move at least a good portion of that money into something safer if you see a crisis looming.

Individuals these days can put their money in a wide range of investments, each with its own level of risk: stocks, bonds, cash, real estate, derivatives, cash value life insurance, annuities, and precious metals are a few of them. You can even dabble in alternative holdings, perhaps with a small interest in a producing oil and gas project.

Spreading your wealth across several of these categories is the best way to ensure that you have something left if the bottom really falls out.

Fly to Safety

Whenever there is real turbulence in the markets, most professional traders move to cash or cash equivalents. You may want to do the same if you can do it before the crash comes.

If you get out quickly, you can get back in when prices are much lower. Then, when the trend eventually reverses, you can profit that much more from the appreciation.

Get a Guarantee

You probably don’t want all of your savings in guaranteed investments. They just don’t pay off well enough. But it’s wise to keep at least a small portion in something that isn’t going to fall with the markets.

If you are a short-term investor, bank CDs and Treasury securities are a good bet.

If you are investing for a longer time period, fixed or indexed annuities or even indexed universal life insurance products can provide better returns than Treasury bonds. Corporate bonds and even the preferred stocks of blue-chip companies can also provide competitive income with minimal to moderate risk.

Hedge Your Bets

If you see a major downturn ahead, don’t hesitate to set yourself up to profit directly from it. There are several ways you can do this, and the best way for you will depend on your risk tolerance and your time horizon.

If you own shares of stock that you think are going to fall, then you could sell the stock short and buy it back when the chart patterns show that it’s probably near the bottom.

This is easier to do when you already own the stock you’re going to short. That way, if the market moves against you, you can simply deliver your shares to the broker and pay the difference in price in cash.

Another alternative is to buy put options on any stocks that you own that have options or on one or more of the financial indices. These derivatives will increase enormously in value if the price of the underlying security or benchmark drops in value.

Pay Off Debts

If you have substantial debts, you may be better off liquidating some or all of your holdings and paying off the debts if you see bad weather approaching in the markets. This is especially smart if you have a lot of high-interest debt such as credit card balances or other consumer loans. At least you’ll be left with a relatively stable balance sheet while the bear market roars.

Paying off your house or at least a good chunk of your mortgage also can be a good idea. Minimizing your monthly obligations is never a bad idea.

Find the Silver Tax Lining

If you are not able to directly shield your investments from a collapse there are still ways you can take the sting out of your losses.

Tax-loss harvesting is one option for losses sustained in taxable accounts. You simply sell all of your losing positions and buy them back at least 31 days later. (That means selling before the end of November to realize the loss before Jan. 1.)

Then you can write all of your losses off against any gains that you have realized in those accounts. You can carry forward any excess losses to a future year and also write off up to $3,000 of losses each year against your ordinary income.

Consider Converting to a Roth Account

If you own any traditional IRAs or other qualified retirement plans from former employers that you can move, consider converting some or all of them into Roth IRAs while their values are depressed. This will effectively reduce the amount of the conversion, and thus the taxable income that you must declare.2

For example, a 30% drop in the value of a $90,000 IRA means $30,000 less that you will not have to pay taxes on if you convert the entire balance in one year.

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This strategy is a particularly good idea if you happen to be unemployed for part or all of the year, because you may be in one of the lower tax brackets even with the conversion.

What Are The 4 Types of Bonds?

Investment bonds are issued by thousands of different governments, government agencies, municipalities, financial institutions, and corporations. They all pay interest. Following are some important considerations about each of the major type of bonds.

Municipal Bonds

Municipal bonds are issued by various cities. These are tax-free but have slightly lower interest rates than corporate bonds. They are slightly more risky than bonds issued by the federal government. Cities occasionally do default.

Corporate Bonds

Corporate bonds are issued by all different types of companies. They are riskier than government-backed bonds so they offer a higher rate of return. They are sold by the representative bank.

Fixed Rate Bonds

In Fixed Rate Bonds, the interest remains fixed throughout the tenure of the bond. Owing to a constant interest rate, fixed-rate bonds are resistant to changes and fluctuations in the market.

Inflation Linked Bonds

Bonds linked to inflation are called inflation-linked bonds. The interest rate of Inflation-linked bonds is generally lower than fixed rate bonds.

Bottom Line

Despite their complicated nature and potential downside in deflationary periods, inflation-linked bonds are still enormously popular. They are the most trusted investment vehicle to hedge against short-term inflation. The corrosive effect that inflation can have on returns is a strong motivating factor behind the popularity of these bonds.

An additional upside of inflation-linked bonds is that their returns do not correlate with those of stocks or with other fixed-income assets. Inflation-linked bonds are a hedge against inflation, and they also help to provide diversification in a balanced portfolio.