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High inflation can wreak havoc not only on household budgets but on investment portfolios as well, hitting certain assets and generally making it more difficult for returns to outpace rising prices. That doesn’t mean investors can’t make moves to protect their wealth from high inflation. 

In June, inflation hit its highest level in nearly 41 years, with the consumer price index rising 9.1% from a year earlier and 1.3% from May, the Bureau of Labor Statistics reported Wednesday.

Putting Inflation in Perspective

Despite the scary headline numbers, investors must consider how inflation affects them personally, said David Blanchett, managing director and head of retirement research at PGIM DC Solutions.

The government’s inflation numbers represent an average from a basket of consumer goods that affect people differently, Blanchett said. Fuel, used cars and airline tickets were up earlier this year, but health care costs didn’t rise much, he noted. 

“No one is actually average, we all are experiencing inflation in different ways,” he said. “It’s really important for investors to understand how inflation is affecting them and then think about how to hedge it.” 

If the things you buy haven’t seen dramatic rises in prices, Blanchett said, “then your need to hedge inflation is perhaps lower.” 

Take housing, for example. Clients who own real estate have a place to live and an asset that shields them from rising rents, he noted. Inflation could affect renters a lot more, so it may make sense for them to own more assets that would do well with higher inflation, according to Blanchett. 

While Series I savings bonds offer a good return, rents across the country have soared over the past year. Riskier assets like commodities might offer a less specific hedge to inflation and potentially better returns, Blanchett said. 

“In theory you want to own assets that hedge your risks or liabilities more directly,” Blanchett said, adding that “it really depends the role your portfolio is playing in terms of covering your expenses versus just say the wages you earn from your job, which for lots of folks have also been rising a lot faster than inflation.”

Here are some other investments that can help clients manage inflation. Of course, no investment is ideal for every client. Blanchett and Christine Benz, Morningstar’s personal finance director, laid out some things to consider.

1. I Bonds

Series I savings bonds, or I bonds, “are a straightforward way to obtain inflation protection,” Christine Benz, Morningstar’s director of personal finance, noted in a recent email. “The big negative is that purchase constraints limit their utility for larger investors.”

I bonds earn interest through a combination of fixed and inflation rates. The initial interest rate on new I bonds is 9.62% through October 2022, with the rate applied to the six months following the purchase date.

Investors may purchase I bonds electronically through the government’s TreasuryDirect website, but they’re limited to $10,000 a year when buying them that way, $5,000 if buyers use their federal income tax refund to purchase the bonds in paper form, or $15,000 if they combine the two methods.

Another detail that may give some investors pause, according to a Morningstar column, is that I bonds pay interest only when sold rather than on a regular basis, and owners must hold the bonds for at least a year before selling.

I bonds earn interest until they reach maturity at 30 years or the owner sells them. They are not held in mutual funds.

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Treasury inflation-protected securities also protect against inflation, with the principal increasing or decreasing based on inflation or deflation. TIPS investors receive interest — a fixed rate tied to inflation — twice a year and the higher of the adjusted or original principal at maturity.

“A cousin of I bonds, TIPS are a way for larger investors to obtain additional tax breaks,” Benz told ThinkAdvisor. “On the negative side, core TIPS funds are extremely interest-rate sensitive, and we're often seeing interest rates jump up at the same time inflation is running high. That's why I like short-term TIPS funds like VTIP,” she said, referring to the Vanguard Short-Term Inflation-Protected Securities ETF.

“TIPS are also tax-inefficient; they should be housed inside investors' tax-sheltered accounts,” she added.

Blanchett said that while TIPS are a relatively safe investment, most people buy them through pooled instruments like mutual funds, which is where the interest rate risk comes into play; rising interest rates could translate into a loss in the bonds’ value. This risk doesn’t apply to actual TIPS held to maturity, he noted.

TIPS come in 5-, 10- and 30-year maturities, and investors buying them through TreasuryDirect must hold them at least 45 days. Interest income and principal growth are subject to federal income taxes but exempt from state and local income taxes.

TIPS typically generate low yields that give them a higher inflation risk than bonds with similar maturities, according to last week’s Morningstar column, In addition to VTIP, Morningstar also cited the Vanguard Short-Term Inflation-Protected Securities Index (VTAPX) and Schwab U.S. TIPS ETF (SCHP) among the top TIPS funds to position against inflation.

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3. Other Fixed Income

Wells Fargo noted that millions of Social Security beneficiaries received a 5.9% annual cost-of-living increase in 2022, the largest in 40 years but not enough to keep pace with this year's inflation. Rising inflation is eroding spending power, especially for those on fixed incomes, the firm said.

Investors looking to supplement their Social Security checks might consider adjusting their portfolios with municipal bonds, U.S. Short Term Taxable Fixed Income and U.S. Intermediate Term Taxable Fixed Income, Michael Taylor, Wells Fargo investment strategy analyst, suggests in a note.

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4. Commodities

Commodities are among a handful of other asset types that have performed well during this high-inflation period, “yet they’re also super-volatile and could do an about-face if inflation weakens,” said Benz.

In 2021, she wrote a column citing the hazards of trying to defend against inflation with these very volatile assets, noting that while commodities appear lucrative, investors often time their investments poorly, essentially buying high and selling low.

Morningstar considers Pimco Commodity Real Return Strategy (PCRAX) among the best commodities funds, according to the firm’s column last week, which also noted that Russ Kinnel, director of manager research, suggests limiting commodities fund positions because of the asset’s volatility and unpredictability.

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5. Stocks

Equities haven’t proven much of a hedge this year but in the long term, they’ve tended to out-earn inflation, Benz noted.

Blanchett made a similar point in a recent interview, noting that 2022 has been unique in that stocks and bonds are down and inflation up.

“In the grand scheme of things if you really are a long-term investor, the outlook on stocks really is more attractive today because of valuations,” Blanchett said. Year-to-date, he said, stocks’ long-term outperformance over inflation “is very much disconnected,” he said.

Morningstar notes that companies differ when it comes to inflation, with some able to pass along higher prices to consumers and others able to maintain profit margins without worrying about raw material prices. The firm cites five companies it considers inflation resistant: Biogen, Clorox, Roche Holding, Sanofi and Unilever.

Wells Fargo suggests that income-seeking investors looking to resist inflation consider high-quality, dividend-paying large-cap stocks. The firm also suggests alternative investments with stable yields that don't move in connection with the broad equity markets.

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6. Delayed Social Security Claiming

For retirees or those approaching retirement, Blanchett said, “the only place that you can get guaranteed income that is explicitly linked to inflation is the late claiming of Social Security.” Most people claim early — 62 is the most common claiming age — but if you claim early, not only is your payment is lower, but you have to invest your money in a portfolio and hope it lasts for 30 years, Blanchett said.

The delayed claiming option is for people who have saved a lot (or are working) and can afford to do so, which many cannot, he noted. The risk with retirement is retirees living to 100 and spending down all their money. TIPS and I Bonds may hedge against inflation but they don’t guarantee that inflation won’t harm a retiree who lives a long time, he said. The longer they can delay claiming, the more they can assure that won’t happen, according to Blanchett.

He suggested that people start thinking about this in their 50s.

If you’re approaching retirement and this recent shock in inflation has you worried and you want something that’s an explicit hedge to that as long as you live, “delayed claiming in Social Security makes more sense today than ever,” Blanchett said. Inflation “has made the benefits of a product like Social Security more valuable, given it’s so unique,” he said. “This is the only thing … that’s both guaranteed for life and linked to inflation.”

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