Inflation - What Are the Best Inflation Hedges?
In a prior article I discussed how gold (the classic hedge against inflation) has benefits more in the long term (spans of ~100 years) and has shown less benefit (minus a period of time in the 1970s). The brings up the obvious question: If not gold , then what ? So let us have a look at some possible alternatives to gold as a hedge against inflation.
Bonds as a Hedge Against Inflation
Explanation of how bonds can act as an inflation hedge:
Bonds are a type of debt security that pay a fixed rate of interest to the bondholder. When interest rates rise, the value of existing bonds can fall. However, if the rate of inflation is rising faster than the interest rate on the bond, the real return on the bond will still be positive. Therefore, investing in bonds with a high rate of interest can act as a hedge against inflation.
Types of bonds that can be used to hedge against inflation:
Not all bonds are the same (ask any chemist). For example, here are 4 types of bonds you might hear people discuss related to inflation hedge.
TIPS (Treasury Inflation-Protected Securities) are a type of bond issued by the US government. The principal value of the bond increases with inflation, meaning that the bond's value will keep pace with inflation. In other words, approximately zero losses during recessions and down turns.
I Bonds (Inflation-Protected Bonds) are another type of bond issued by the US government. The interest rate on these bonds is based on both a fixed rate and a variable rate that is tied to inflation.
Corporate bonds are issued by companies, they may offer higher rates than government bonds, but are also higher risk.
High yield bond (Junk bonds) tend to have a higher rate of return, but also a higher default risk.
I-Bonds vs TIPS:
Both are supported by the full confidence and credit of the American government - there is practically no risk.
Both asset classes to experience about zero short-term capital losses or share price drops during downturns and recessions.
TIPS returns take the form of higher cash dividends to shareholders - paid monthly. TIPS tends to yield a tiny bit more (like 0.1%) than I Bonds - but that could increase
I Bonds, returns take the form of higher interest rates - set semi-annually
If interest rates rise TIPS prices can decrease leading to capital loses. If the interest rates drops, then it can lead to capital gains. There are no capital gains or loses on I Bonds — because the payment is in interest.
Both are excellent - very low risk options.
Real estate as a Hedge Against Inflation
Explanation of how real estate can act as an inflation hedge:
Real estate can act as an inflation hedge in a few ways. Firstly, if the property is leased, the landlord may be able to increase rent to keep pace with inflation. Additionally, the value of the property may appreciate as inflation increases, which can increase the overall value of the property.
Types of real estate that can be used to hedge against inflation:
Residential properties that can be leased out can provide a steady source of rental income that can increase with inflation.
Commercial properties, such as office buildings or warehouses, can also provide rental income.
Infrastructure investment, such as investing in toll roads, bridges, or airports.
Real estate performance during periods of inflation:
Real estate in the past 40 years has had ~ 0% real rental rate growth. Averaged over time , this is a pretty clean hedge with inflation. Source: PGIM Real Estate, 2022 Global Outlook: Investing Through Uncertainty, May 2022
The data on property value and inflation, shows gains in office buildings (1.2%) and apartment (1%) for each 1% increase in inflation. Source: Columbia Threadneedle Investments, 7/13/22 https://www.columbiathreadneedleus.com/binaries/content/assets/cti-institutional/insights/blogs/how_does_real_estate_perform_in_inflationary_environments.pdf
Rent is tricky, unless you plan on raises it on your tenants — or have that priced into the contract. The value of the actual asset seems to hold pretty steady - in most cases.
Bitcoin as a Hedge Against Inflation
As this website is title “crypto war machine” obviously I have to discuss the use case of Bitcoin as a hedge against inflation — and I will in detail in the next article.
Remember — nothing I say is financial advise.
