Inflation has been a growing concern in the economy, as it not only decreases consumers’ purchasing power, but also decreases return on investments (ROI). When excluding food and energy, inflation rose by 6.0% for the 12-month period ending in January. According to the Bureau of Labor Statistics, this represented the “largest 12-month change since the period ending August 1982.” In times of high expected inflation, fixed-income investments such as bonds lead to a decrease in real returns, which is one of the underlying risks in the bonds market. For example, a 3% coupon rate with inflation at 2% leads to an increase of only 1% in real return.
While awaiting the Fed’s increase in interest rates, bond investors can use different strategies to reduce inflation risks related to the investments they have already made. The strategies can include a diversified portfolio with a mix of stock/bond, investing in gold and/or commodities, real estate, and Treasury Inflation-Protected Securities (TIPS).
When choosing between strategies, it is important to investigate the short and long-term goals of the investment and list out the various benefits as well as losses each type of investment holds. For instance, buying gold can be a good strategy to hedge risk because of its variable price. In inflationary times, the cost of every ounce of gold increases and compensates owners of gold. But, if the price of gold does not rise as expected, then this strategy may not help. The same is true for Treasury Inflation-Protected Securities (TIPS), as stated by financial adviser Raymond James for the New York Times, “rising interest rates can sap TIPS’s returns.” The additional issue with TIPS is the lower interest payments when compared to traditional Treasuries. Another example is related to commodities investments, even though their prices often rise with inflation, their nature is extremely volatile because of sudden drops in prices.
Overall, times of inflation can be nerve-wracking for consumers and investors. Nevertheless, researching good strategies that fit the investment profile, talking to financial investors, reading the news, as well as keeping a diversified portfolio, may bring peace of mind while waiting for Fed’s policies to combat inflation in the upcoming months.