How to Manage Your Money if Inflation Flares

While long-term investors may want to stick with standard diversified stock and bond funds, hedges are available for those who worry that inflation will get out of control.

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In the end, inflation may not turn out to be a big problem.

But it’s already being discussed enough by the Federal Reserve and a host of economists to raise a crucial question: How can investors protect their portfolios if inflation persists?

Inflation flared this spring, and in June, Jerome H. Powell, the Federal Reserve chair, said, “Inflation could turn out to be higher and more persistent than we expect.” And Fed officials now allow that interest rates might need to rise sooner than anticipated last year, and they have begun discussing when to start tapering $120 billion in monthly bond purchases.

On the other hand, much of the recent surge in prices can be linked to the economic recovery from the pandemic, and the situation a year or two from now can’t be predicted reliably. It may all turn out to be “transitory,” as the Fed has maintained.

Nonetheless, for many investors, there’s enough concern that it’s worth considering some basics.

Some Investment Fundamentals.

First, even those worried about inflation should remember that over long periods of time, diversified portfolios are likely to do the best. If you can afford to wait it out, one reasonable approach to inflation is just to ignore it.

If inflation does persist, however, those who want to take a more active approach might do well to dedicate a slice of their portfolios to investments that have thrived during previous inflationary cycles. Commodities, gold, some areas of the stock market and even cash are among inflation’s historical beneficiaries. Bonds are not.

Stocks did not fall during the last prolonged period of inflation, from 1973-9. However, they didn’t quite keep up with annual inflationary price increases of 8.8 percent. Large-cap stocks gained 3.26 percent a year during that period, according to Morningstar Direct.

Certificates of deposits and savings accounts, which are paying very low yields with the current low interest rates, could be expected to offer far more appealing returns in an inflationary environment. But the historical record shows that those willing to take the risk have found better places to keep their money during times of inflation.

Consider the Case for Commodities.

“Commodities are historically the most reliable hedge against inflation,” said Amy Arnott, a portfolio strategist with Morningstar. Commodity prices are volatile, however, and it is difficult to time their rise and fall reliably. Lumber prices, for example, rose sharply this year but declined in June as supply bottlenecks cleared up.

Still, commodities — including metals, oil and gas, agricultural products — rose 19.4 percent a year from 1973 to 1979, as measured by the benchmark S&P GSCI index, according to Morningstar Direct.

Jason Bloom, head of fixed income and alternatives exchange-traded fund product strategy at Invesco, said industrial metals, especially copper, could rise in coming years, and not necessarily because of inflation. Copper could benefit from its use in electric vehicles, as well as in wind and solar energy generation.

“We think over the next five years it’s within the bounds of reason for the price of copper to double,” he said. He also expects further gains for the prices of oil and agricultural commodities.

“There is a longer-term view that as wealth grows in developed countries, consumers will shift to higher protein levels,” he said, spurring demand for cattle and hogs, along with the corn and soybeans that feed them.

Michael Arone, chief investment strategist at State Street Research, which runs many E.T.F.s, said, “I think energy and materials stocks represent good value.” State Street’s SPDR SSgA Multi-Asset Real Return E.T.F. focuses on inflation. It is a collection of E.T.F.s that invest in real estate, commodities and Treasury Inflation Protected Securities. The fund returned 16.9 percent through June and has an expense ratio of 0.5 percent.

While Mr. Arone says he expects inflation to ebb in the years ahead, it’s worth monitoring potential wage inflation. “To me, if the average hourly earnings rise comes close to 4 percent, that would be concerning,” he said.

Phillip Toews, chief executive of Toews Asset Management, an investment adviser with more than $2 billion in assets under management, favors a “small” allocation to a commodities index — “perhaps 5 to 10 percent” — in client portfolios. Because bonds are vulnerable in inflationary periods, Mr. Toews says he recommends TIPS, which provide the safety of bonds along with explicit protection against possible inflation.

Switching Among Asset Classes.

Some funds, like the Fidelity Multi-Asset Income fund, have broad mandates that can provide an internal hedge against inflation. Adam Kramer, a manager of the Fidelity fund, says it can invest in equities, Treasuries, investment-grade corporate bonds, high-risk bonds, preferred stock and convertibles, and he can alter its asset allocation when appropriate.

Mr. Kramer said he seeks asset classes that already reflect all the bad news possibilities and don’t fully reflect good news possibilities yet. “I’m just looking for those areas where there’s too much bad news baked in,” he said.

He views some real estate investment trusts as likely beneficiaries of inflation. He favors the Simon Property Group, a mall owner, and VICI Properties, which owns Las Vegas casinos. Such trusts have generally performed well during inflationary periods, rising 11.53 percent from 1973 to 1979, according to Morningstar Direct.

Gold rose an annualized 34.78 percent during that period, and Mr. Kramer has holdings in two mining companies, Newmont and Wheaton Precious Metals .

And gold would do especially well, said Mr. Kramer, if inflation persisted but the Fed was slow to raise interest rates in response.

The Fidelity fund returned 13.1 percent through June and has an expense ratio of 0.85 percent.

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