How to invest during inflation?

If you are investing for the long-term and aiming for peace of mind about your investments, it is best to keep a diversified portfolio of assets. This means mixing asset types that benefit from high inflation with those that are inflation-neutral or those that perform best during times of low inflation.

Having said that, money managers often advise investors to rebalance their portfolios in times of high inflation and shift more funds into assets that typically fare better when prices are rising. Before you do this, one crucial factor to investigate is whether the uptick in inflation is temporary or permanent.

• If consumer prices increase because of a one-off factor, chances are that inflation will not be permanent and you may be better off riding out the storm without reshuffling your investments.
• At times of persistently high and rising inflation, like the one most of the world has been experiencing since 2022, it is best to take a proactive approach and search out those financial assets that have the highest chance of combating the negative impacts of inflation.

Keeping those ideas on diversification in mind, here are a few asset types that may help you hedge against inflation.

Stocks

Are stocks good during inflation? In general, stocks are best suited for long-term investment; so if that is your investment horizon, stocks are a good idea to have in your portfolio regardless of the current inflation situation.

If you are specifically looking for stocks that perform well in a high-inflation environment, look for industries that profit from high inflation, such as energy, banking or real estate. By contrast, service providers or manufacturers that rely on consumer spending may see a dip in their performance if consumers' purchasing power drops because of high inflation.

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Commodities

Prices of commodities such as metals, oil, natural gas or grains tend to rise in periods of high inflation. In fact, rising commodity prices are often a leading underlying cause of consumer price inflation. Holding commodities - for example through an exchange-traded fund (ETF) that invests in them - is therefore a good inflation hedge.

Gold

When discussing how to hedge against inflation, gold often comes up as an alternative. Because of its finite supply, it tends to hold its value well, although the lack of meaningful returns makes it a less attractive option for many investors.

Real estate

Is real estate good to own during high inflation? Yes, because real estate prices and rental income generally tend to rise over the long term, but especially so during times of high inflation. If you think buying an actual piece of real estate is too cumbersome, risky or simply beyond your means, you may want to invest in real estate investment trusts (REITs), or ETFs that track the broader property market. REITs are companies that own and operate income-producing real estate.

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Inflation-protected bonds

Inflation-indexed bonds, usually issued by governments, are designed to protect investors against the devaluation of their principal and/or interest payments in times of high inflation. In some cases, the principal of the bond is adjusted regularly for inflation; in other instances, these bonds come with floating-rate coupons that offer a premium above the prevailing inflation rate. Examples of inflation-indexed bonds include Treasury Inflation-Protected Securities (TIPS) in the US or index-linked gilts in the UK.

To find a bond investment that works for you during times of high inflation, take a look at the best brokers for bonds.

While there is no certainty that certain assets will perform well when inflation is high, some will surely fare poorly. The two financial instruments you should avoid in a high-inflation environment are cash and fixed-rate bonds.

Keeping a certain amount of liquid cash at hand is a prudent thing to do, but when inflation runs high, you may want to invest your cash, except what you may reasonably need in case of an emergency. Whatever cash you decide to keep, put it in a savings account, as earning a small interest is still better than no interest at all.

As a rule of thumb, inflation and fixed-rate bonds do not mix well. First of all, when inflation runs high, the return on fixed-rate bonds declines when adjusted for inflation. Second, if inflation is expected to persist, central banks will respond by raising interest rates. This is bad news for bondholders, because there is an inverse relationship between interest rates and bond prices. When interest rates are rising, the price of bonds typically falls because the fixed-rate interest it pays becomes less competitive.