The Best Inflation Hedge
Key Takeaways
Inflation might not have been a significant consideration in the past, but its recent spikes have made it an important aspect to consider when planning for the future.
Gold is often cited as a great inflation hedge, but the best proven way to grow your assets sustainably is by mixing it up: balance of diversified stocks, bonds, and other investments that reflect your goals, the returns you desire, and the possible losses you are able to take)
Inflation is taxation without legislation.
— Milton Friedman
A recent school alumni gathering brought about the usual catch-up talk like where everyone was working, what the children were up to, reminiscing about canteen food, and the lamentation that at the moment, Singapore is probably one of the most expensive places in the world. Although inflation has always been present, the spike over the recent years has made its presence more noticeable — from transport prices to the humble bowl of fishball noodles.
We have to be aware of the quantum of money required now, to meet higher expenses in the future. Many investors consider cash investments to be a safe investing decision, but with inflation on the rise, cash investments may actually introduce a different type of risk to your portfolio — the risk of not having sufficient assets to live the lifestyle that you desire.
Gold is commonly touted as a tool for protecting wealth from rising prices. But history shows the challenges of using gold to offset the impact of inflation. Looking to as far back as the 70s, gold has often experienced large price swings relative to annual inflation, shown in the chart below. An effective inflation-hedging tool should have return volatility that is more on par with changes in consumer prices. In addition, you would want your asset prices to have a closer correlation to inflation.
Mix it up
Your asset allocation should be a balance of diversified stocks, bonds, and other investments that reflect your goals, the returns you desire, and the possible losses you are able to take — not only single instruments which you buy or sell depending on the present theme.
For instance, when we include other broadly diversified asset classes such as global stocks and intermediate bonds into the chart, you will notice that these asset classes have different returns from each other and can be positive when others are negative and vice versa.
What is the criteria for including these asset classes as inflation hedges? In a wide ranging study which measured the effect of US inflation and global asset classes over a long sample period (1927-2020), data showed that stocks and bonds (but not cash) have the potential to outpace inflation.
More importantly, stocks; had returns significantly above inflation — with value stocks doing much better in general. The diagram below shows real returns (return after accounting for inflation) in Panel B.
Work Smarter Not Harder
So there is no need to chase or seek investments that purportedly outperform during periods of high inflation or rising rates. A diversified portfolio with a mix of stocks, bonds and gold will do just fine with occasional periods of downside but with the ability to match and outpace inflation — preserving your hard earned money.
Whether or not you are worried about inflation, pandemics, trade wars and the multitude of future crises that we are likely to encounter; building a strong, diversified portfolio is key to long-term investment success.
If you are worried about how inflation could impact you, or your investments, come and speak to us.
