Some say inflation is easy to understand but the impacts from it are anything but easy – especially the impact on your investment portfolio. So let’s dig in a little – What is inflation and what are the best investments for rising inflation?
How are we at Cashflows & Portfolios fighting inflation with our investment portfolios?
Read on to find out and of course, comment away including what you’re doing about it.
What is inflation?
At the most basic level, inflation is an increase in the price of goods and services over time.
For example, if the inflation rate is 2%, then a loaf of bread today that costs $1 will cost $1.02 the next year. Of course, bread is more expensive than $1 or even $1.02.
Simply put, inflation erodes purchasing power.
Are there benefits to low inflation?
What are the Best Investments for Rising Inflation?
In terms of your investment portfolio, here are a few quick considerations for the best investments for rising inflation:
1. Stick to a bias of stocks.
We believe a stock portfolio unto itself can be a good inflation hedge. Companies can push their increased manufacturing and service costs back onto customers, to a point, to keep their revenues flowing in and costs may climb. Of course, some stocks such as those in the following sectors may be more inflation-friendly than others:
- Consider owning Real Estate Investment Trusts (REITs).
- Consider owning commodities.
- Consider owning materials.
2. Consider the “Permanent Portfolio”.
The permanent portfolio is an investment portfolio designed to perform well in all economic conditions. It was devised by free-market investment analyst, Harry Browne, in the 1980s. This portfolio is composed of equal parts stocks, bonds, gold, and cash. In terms of low-cost U.S. ETFs, it looks a little bit like this:
“So if many portfolio managers and financial planners don’t consider serious inflation or the possibility for a change in economic conditions (economic regimes) it’s not surprising that the everyday retail investor would not ‘get it’. And by the way, I am told that advisors and planners are not trained ‘on this’. They are not trained to protect your wealth in all economic conditions. The word “stagflation” does not show up in their training materials.”
3. Own the TSX!
Yup, not all sectors are negatively impacted by inflation. So, to hedge your portfolio against inflation, consider investing in sectors that will see pent-up demand, like oil, electricity, and real estate. In fact, one could make a case that financials might do well in a slightly inflationary environment. When it comes to those sectors, look no further than the TSX.
Sure, as far as recessions go, banks and large financials are probably not ideal investments for superior short-term returns. Banks are very cyclical in that sense – when bad times hit – you’ll see housing demands drop, you’ll see other loan demands drop and we saw this during the first part of the COVID pandemic. But, banks are gonna bank. Banks are engineered to make money, lots of it, during mildly inflationary environments.
So, with that, given the TSX index is heavily weighted in both energy and financials, it might not be a bad place to keep some of your money during some inflationary times, let alone as part of a long-term investment plan, in the TSX.
See the following sector allocation in the Vanguard Canada – FTSE Canada All Cap Index ETF (VCN):
Sector | Fund | Benchmark | +/- Weight |
---|---|---|---|
Financials | 33.0% | 33.0% | 0.0% |
Energy | 13.7% | 13.7% | 0.0% |
Basic Materials | 11.5% | 11.2% | 0.3% |
Technology | 11.4% | 11.4% | 0.0% |
Industrials | 8.6% | 8.6% | 0.0% |
Consumer Discretionary | 6.0% | 6.0% | 0.0% |
Utilities | 5.3% | 5.7% | -0.4% |
Telecommunications | 5.0% | 5.0% | 0.0% |
Real Estate | 2.3% | 2.3% | 0.0% |
Consumer Staples | 2.2% | 2.2% | 0.0% |
Health Care | 0.8% | 0.8% | 0.0% |
Total | 100.0% | 100.0% |
Source: Vanguard Canada.
How are we at Cashflows & Portfolios fighting inflation with our investment portfolios?
Well, in fact, we’re doing next to nothing.
For one, we already own a nice basket of stocks via low-cost ETFs to ride the market returns. We outlined some of our favourite low-cost ETFs in this post here:
Build Long-Term Wealth using our Diversified ETF Model Portfolios
Second, we also happen to own a few dividend-paying stocks in each of our portfolios. We own some REITs, commodities and some material stocks (e.g., Nutrien (NTR)) to help fight inflation.
Lastly, we’ve seen this movie a bit before. We’ve learned from The Four Keys to Investing Success.
Inflation is bound to rise and fall and rise overtime again. As such, we’ve designed each of our portfolios based on lessons learned from history to hold a bit of cash (maybe not as much as Harry Browne!) and keep other sectors in our portfolio (such as some technology stocks) through indexing the U.S. market. This way, using the tech sector-heavy U.S. market as an example, that’s a small hedge to ride out any higher but short-term inflationary period. I mean, who doesn’t like a new iPhone now and then? Will people really stop using paying their electricity bill to use the internet? We doubt it.