Are you looking for investments that hedge against inflation? If you’ve been paying attention to prices lately, then you probably are. Why? Because the purchasing power of the dollar is down as prices are way up.
- Lumber is up 308%
- Corn prices are up 85% from last year
- Crude oil prices are more than double what they were in 2020
- Steel prices are setting record highs
- Average home prices are up 9.6% from last year
- And used cars are up 10% in the month of April 2021 alone
I could go on and on, but you get the picture. The consumer price index (our measure of inflation) is up 4.2% from last year. That’s the greatest increase in the consumer price index (CPI) in more than twelve years.
To keep that in perspective, the Federal Reserve targets 2.0% yearly increases in CPI. And CPI was 1.4% in 2020. So if your wallet is feeling lighter these days, it’s not your imagination, prices are definitely up.
Now the real question is, will this just be a temporary spike or are these higher prices here to stay? At this point, it’s hard to say, as only time will tell.
But as an investor, it’s imperative that you’re investing in assets that beat inflation. If you aren’t, then you’re future purchasing power is going backward and that’s not good. In essence, you’re losing money.
With that in mind, let’s look at four investments that can keep your wealth growing by acting as a hedge against inflation.
1. Multifamily Real Estate
If you’ve watched our video, 9 Reasons to Invest in Multifamily Apartments, then you know that commercial real estate has historically been a great hedge against inflation. Probably the best way to illustrate that is to compare the National Council of Real Estate Investment Fiduciaries Property Index (NPI) to the consumer price index (CPI).
NPI is an unleveraged composite total return for private commercial real estate properties held for investment purposes. It’s the most widely used index for evaluating the performance of private real estate. NPI has been tracked on a quarterly basis since the last quarter of 1977, so we have more than four decades worth of data to scrutinize.
As you can see from the graph, commercial real estate has a long consistent track record for beating inflation. In fact, NPI has exceeded CPI 37 of the last 43 years. In contrast, the S&P 500 has only exceeded CPI 29 of those 43 years. Over the last decade, returns from NPI averaged almost six times the rate of inflation.
It’s important to remember that NPI is a composite index made up of office, retail, industrial, and multifamily real estate. As such, NPI underrepresents the value of multifamily as a hedge against inflation.
This is true because multifamily leases typically run 6-12 months. That allows owners to respond quickly to inflation by raising rents. Office, retail, and industrial properties typically have longer leases, ranging from three to ten years in duration. These longer leases are less than ideal for raising rents in a timely manner during times of inflation.
2. Precious Metals
Precious metals (gold, silver, and others) are known to be a strong hedge against inflation. Consider the graph below:
The intrinsic value of gold has held up nicely in the face of inflation. As the graph shows, from 1971 through 2018 when CPI exceeded 3%, gold returns flourished.
It is clear that precious metals have offered investors a safe haven during inflationary times. However, these investments do have some downsides. One of those is the need for safe and secure storage. Gold and silver take up space typically requiring either a safe deposit box or a personal safe for storage.
Also, precious metals are volatile. Their prices go up and down from moment to moment and can take years to realize significant price increases.
Unfortunately, during these long hold periods, precious metals do not spin off any return. Unlike real estate, which produces ongoing cash flow from rents, precious metals only pay the investor when they sell them at a profit.
Lastly, the IRS considers precious metals to be collectibles. Unfortunately, that means that they incur a higher capital gains rate than many other investments (real estate included).
3. Treasury Inflation-Protected Securities (TIPS)
I have to warn you that bonds are not sexy. However, sometimes bland vanilla hits the spot, especially when inflation is raising its ugly head. If you agree then Treasury Inflation-Protected Securities (TIPS) might be right for you. These government bonds typically have maturation dates of 5-, 10-, or 30-years. Unlike other bonds, they do not have a fixed rate. Instead, their returns are tied to CPI.
Therefore, the principal will rise with inflation and fall with deflation. At maturation, the investor will get the inflation-adjusted principal or their original principal – whichever is greater.
Since the principal rises with inflation, the interest payments will go up as well. The coupon rate doesn’t change, but when multiplied against a larger principal, the returns increase.
Unfortunately, TIPS tends to have a lower interest rate than other bonds. So while they do offer some inflation protection, they are often less than ideal for income investors.
To give you some perspective on that, the 10-year TIPS was auctioned on March 15, 2019, with an interest rate of 0.875%. In comparison, on that same day, the 10-year Treasury note was auctioned with an interest rate of 2.625%. Both of those numbers are anemic when compared to commercial multifamily yield returns over the last ten years.
4. Commodities
Commodities are often touted as investments that hedge against inflation. And of course, there is some truth to this. In fact, commodity price increases are seen as a leading indicator of inflation. When people see prices starting to spike, the concern is that inflation will follow.
Commodities represent a broad category of items including precious metals. Other items within commodities are sources of energy like oil, electricity, and natural gas. Countless food items like beef, lettuce, and grain also fall under the heading of commodities. Foreign currency, cotton, uranium, coffee and much more are all considered commodities.
There are exchange-traded funds (ETF) available to invest in a wide variety of commodities rather than picking individual commodities. Nevertheless, commodity investing is risky.
Commodities are highly volatile and affected by supply and demand dynamics that are difficult to predict. Geopolitical strife, inclement weather, disease, tariffs and more can dramatically affect the price of commodities.
Take, for example, the Colonial Pipeline cyber-attack of May 2021. By shutting down the main supply of gasoline to the South and East Coast, gasoline, home heating oil, and aviation fuels came under severe shortages.
This disruption of supply coupled with panic buying led to more than a doubling of gas prices. Fortunately, it was a short-lived phenomenon, but it underscores just how volatile and unpredictable the commodities market is.
For most people, commodities are highly speculative and not suitable for large-scale investment. While commodities can act as a hedge against inflation, if you don’t have a crystal ball to tell you when to buy and when to sell them, you could lose your shirt in this high-risk asset class.
Do Your Investments Hedge Against Inflation?
It’s been a long time since we Americans have had to worry much about inflation. But you can’t read the news today without seeing countless articles about it. The reality is that inflation is here. The question is will it stay?
Will today’s inflation be just a blip on a chart that moderates rapidly, or will it grow and persist to the point that it threatens your financial future and your retirement savings?
Only time will tell what inflation will do. But if inflationary pressure is here to stay, will you be victimized by it or will you benefit from it? It all depends on whether or not you hold assets that hedge against inflation. That’s right, you can absolutely benefit from inflation. But you have to know where to invest your money.
This article has discussed four investments that hedge against inflation. But real estate stands out head and shoulders above the rest. So if you don’t know much about multifamily real estate, now is the time to learn. I invite you to get started by checking out 37th Parallel Properties’ video, Introduction to Multifamily Investing.
To learn more about commercial multifamily real estate investing, download your free copy of Evidence Based Investing from 37th Parallel Properties.
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