In a world where the value of currency is in constant flux, navigating the landscape of high inflation requires strategic financial choices. As prices for goods and services steadily climb, investors seek assets that not only weather the storm but are more likely to outshine other investment classes in the face of rising inflation. Join us as we uncover some asset classes to invest in when inflation is high.
Disclaimer: The information outlined in this article covers the basics of inflation and stock market investing, and is general in nature. It should not be taken as specific financial advice. Please read our financial disclaimer for more information.
What is inflation?
Inflation is the rate at which the value of a currency is falling and, consequently, the general level of prices for goods and services is rising.[1] The consumer price index (CPI) is a common measure of inflation. It represents the percentage change in the value of a basket of goods and services consumed by households over a specified time period. Investors will often seek assets that can ride out or even benefit from rising inflation. Let’s check out some of the more popular asset classes to invest in when inflation is high.
1. Dividend stocks
Companies that pay dividends are generally larger and earn sufficient revenue to pay dividends to investors. Look for companies that have consistently paid dividends, and that have increased dividends over time. Some popular dividend stocks in the US include 3M, ABM, American States Water, AT&T, Procter and Gamble, Coca-cola Co, and Johnson & Johnson.
Dividend aristocrats, also called dividend champions, are companies that have raised dividends for at least 25 years in a row. Online resources such as dividend.com and time.com provide up-to-date lists of dividend champions.
Similar to dividend aristocrats, dividend kings are companies that consistently raise their dividends. The difference is that dividend kings have increased dividends for at least 50 years in a row. They are older and more established companies with a proven track record of consistently increasing their dividends. Dividend.com and time.com also provide up-to-date lists of dividend kings.
2. Bonds
Bonds are a type of fixed income investment whereby an investor loans money to a government or corporation. The government or corporation issues a contract to the investor, which specifies an obligation to return the borrowed funds, or the principal, to the investor. In addition to the principal, coupon payments are made to the investor over time. This provides a positive return on investment, or yield, to the investor.
For example, a bond of $10,000 issued at a yield of 5% will generate a $500 per year coupon payment to the investor until either maturity or when the bond is sold.
While government and corporation bonds generally have a lower yield compared to stocks, they often have a higher yield compared with inflation. Moreover, they are one of the safest investments around. In the short term, their yield may be lower than inflation, but over the long-run, bond yields have been shown to be higher than inflation.
The following chart shows the 10-year U.S. treasury bonds and the CPI from 1965 to 2022. Most of this time saw the bond rate above the CPI.[2]
Since around 2010, bond yields have not been significantly higher than inflation and since 2020, inflation has increased substantially. Periods where inflation is higher than bond yields often encourage investors to switch their investments out of bonds and into assets that provide higher returns.
Because of the relative safety and long-term inflation advantages, bonds are considered a worthwhile addition to a well-diversified investment portfolio.
NOTE: Interest rates are another factor to consider before buying bonds. As interest rates increase, bond yields are diluted and can provide a lower return than some other investments.
An important lesson from this is that investors must keep an eye on the economy to determine which asset class(es) are preferred for maximizing their gains. In addition, different countries will have different bond rates and inflation rates. This means investors should prioritize their investment decisions based on their local economy. If assets are owned in a different country, the economy of that country will be important.
3. Cash flow businesses
Businesses that continue to receive income and strong cash flow during economic downturns are relatively safe investments during high inflation. Examples of cash flow businesses are grocery stores, pharmaceutical/healthcare companies, software companies, and energy providers.
People rely on these types of businesses regardless of inflation rates, interest rates, conflicts, or other economic volatilities. They can increase the prices of their products or services to ride out any economic downturns. Moreover, they can continue to provide stock growth and/or dividends for investors. Many cash flow businesses are also dividend aristocrats or dividend kings.
4. Mutual funds
Mutual funds are investments managed by companies that invest in diversified assets including stocks, bonds, and real estate. Because they are managed, they incur fees that are paid by the investor.
There are many types of funds, including bond funds, equity funds, money market/currency funds, balanced funds, index funds, exchange-traded funds (ETFs), sector funds, market cap funds, and hedge funds. Some of these fund types overlap in the assets that are managed.
The fees charged by funds are based on the amount of work and the complexity of managing the funds. Index funds and ETFs generally attract the lowest fees as they require minimal work once set up. Hedge funds require more active investing strategies and therefore charge higher fees in line with the performance of the fund.
The following chart shows the performance of the U.S. stock market (taken from the S&P 500) compared with inflation between 2013 and 2022.[3] From its inception in 1957 to 2021, the S&P 500 has shown a strong track record of beating inflation, returning around 10% per year on average.
5. Real estate
In terms of capital appreciation, real estate appreciation often matches inflation over the long run. The following chart compares U.S. home price appreciation with inflation (CPI) from 1890 to 2018.[4]
Real estate investing may not have the same capital appreciation as equities on average. However, it has the advantage of providing cash flow that provides the investor with protection against inflation.
Real Estate Investment Trusts (REITs) can also protect against inflation, with dividend growth outperforming inflation in most years. The chart below compares REIT dividend growth per share with the CPI from 2000-2020.[5]
Final thoughts
Because high inflation erodes the value of currencies, you may hear the “cash is trash” mantra more often. You may be tempted to put more of your cash reserves to work by buying more investments such as the ones listed above. However, it is still important to have a certain amount of cash available for emergencies and for investing when stocks, property or other asset classes can be purchased at a discount.
If you have high-interest debt, it is worth focusing on paying it down with your cash reserves instead of buying any of the assets covered above. This would be equivalent to earning the amount saved compared with not paying down the debt and paying interest on it.
NOTE: As seen in the charts above, there are times when inflation can be greater than the returns of a particular asset class. It is therefore important to research and seek help from a qualified financial adviser when choosing suitable assets to invest in.
Leave a comment below if you invest in other assets to protect against inflation.
