By Peet Serfontein
Inflation-proofing your investment portfolio
Inflation, the general increase in prices over time, erodes the purchasing power of money and affects all aspects of the economy, including investments. For investors, inflation presents a significant challenge as it diminishes the future purchasing power of their investments. To protect against the adverse effects of inflation, investors must adopt strategies that not only preserve but also enhance the value of their investments (over inflation) over time.
Inflation has a different impact on different asset classes
Fixed-income investments like bonds and cash investments tend to suffer during periods of high inflation because their fixed interest payments lose value in real terms. In contrast, equities can provide some hedge against inflation as companies can often pass on higher costs to consumers, although not all sectors perform equally well during inflationary periods. Investments in physical assets like real estate, commodities, and precious metals often retain value better during inflation.ome produced through real estate ownership without individually having to buy, manage, or finance any properties themselves.
Diversification
Diversification is the cornerstone of a resilient investment strategy. By spreading investments across various asset classes, sectors, and geographic regions, investors can reduce the risk associated with any single investment. During inflationary periods, certain assets may perform better than others, and diversification ensures that the portfolio benefits from these outperforming assets, countering the underperformance in others. This includes a mix of equities, fixed-income securities, real assets, and alternative investments, as well as geographic diversification to mitigate country-specific inflation risks and sector diversification to allocate funds across various sectors such as technology, healthcare, and consumer goods.
Investing in equities
Investing in equities, particularly those of companies with strong pricing power, can serve as an effective hedge against inflation. Companies that can pass increased costs onto consumers without significantly reducing demand tend to perform well during inflationary periods. Another good inflation hedge is growth shares - companies with high growth potential can outpace inflation through increased earnings. Focusing on sectors like consumer staples, healthcare, and energy, which tend to be less sensitive to inflation, can also be beneficial.
Real estate investments
Real estate has historically been a strong hedge against inflation. Property values and rental incomes tend to rise with inflation, providing both capital appreciation and income. Investors can invest directly in residential, commercial, or industrial properties, or through Real Estate Investment Trusts (REITs) that offer exposure to real estate without the need for direct property management. Real estate funds, including managed funds and ETFs focused on real estate investments, are also viable options.
Commodities and precious metals
Commodities, including precious metals like gold and silver, often retain value or appreciate during inflationary periods. They serve as a store of value and a hedge against currency depreciation. Investing in gold and silver, as well as a diversified basket of commodities like oil, natural gas, and agricultural products, can be effective. Commodity funds, including ETFs and managed funds that track commodity indices, provide an accessible way to gain exposure to this asset class.
Inflation-linked bonds
Inflation-linked government bonds are specifically designed to protect against inflation. The principal value of the bond increases with inflation, as measured by the Consumer Price Index (CPI). This ensures that the investment keeps pace with inflation, and interest is paid on the adjusted principal, providing an inflation-protected income stream.
Floating-rate bonds
Floating-rate bonds have interest payments that adjust with prevailing interest rates. During periods of rising inflation, interest rates typically increase, and so do the payments on these bonds. This provides a hedge against inflation.
Alternative investments
Alternative investments, including private equity, hedge funds, and infrastructure investments, can offer inflation protection through diversification and unique return profiles. Private equity involves investments in private companies that can grow and adapt to inflation, while hedge funds employ strategies that seek to generate returns uncorrelated with traditional markets. Infrastructure investments, such as those in toll roads and utilities, often have inflation-linked revenues, providing an additional layer of protection.
Inflation-proofing with foreign investments
Investing in foreign markets can provide exposure to economies with different inflation dynamics. Emerging markets, in particular, may offer higher growth potential that can outpace inflation, although they also come with a higher risk, whereas developed markets provide stability and diversification benefits.
Benefits of investing in REITs
Consider seeking professional financial advice to tailor an inflation-proofing strategy to your unique circumstances. Financial advisors can provide personalised recommendations and help navigate complex investment choices.
