Should you try to hedge against inflation?

Many parts of the economy have continued to see a rise in prices over the past several months. According to the Bureau of Labor Statistics, the Consumer Price Index rose 8.6% over the last 12 months as of May 2022.

Throughout the last year and a half, we’ve seen examples of inflation and rising prices for consumers due to tight supply and high demand driven by the post-Covid reopening. Commodities like lumber were particularly impacted, with prices hitting all-time highs in early May 2021. Now it is affecting everything from energy and gas prices to food and household items.

The rise in the Consumer Price Index is the largest 12-month increase since the period ending Dec. 1981. And now, after decades of being virtually ignored as a serious threat, investors are starting to become spooked by the looming specter of inflation and how it could affect their portfolios.

According to Google Trends, a website that analyzes the popularity of top search terms, interest in the term “inflation” hit an all-time high in 2021 as investors try to determine the best investments for inflationary times.

The Federal Reserve is attempting to slow higher inflation with interest rate hikes over the course of the year. Eventually, supply and demand can normalize, but that process could take a few months, or even years, to play out, which leaves the outlook for future inflation unclear. Not to mention the uncertainty in the markets and the continuing war between Russia and Ukraine.

That’s why spending your time worrying about which investments do best during inflation, and making a bet in your portfolio on a specific outcome, could be a losing proposition.

Inflation is not a new phenomenon. Historically, some asset classes tend to perform better than others in periods of rising inflation, just as some outperform when interest rates fall and some fare better in the early stage of an economic recovery.

Take stocks for example.

More often than not, inflation-adjusted returns for stocks are positive (U.S. large-cap stocks outpaced inflation 86% of the time, over rolling 10-year periods since 1926). Of course, past performance doesn’t guarantee any future results.

But some stocks may benefit more than others should inflation pick up; for instance, large value and developed international stocks have shown more positive correlations to inflation over the past few decades.

So with all these mixed signals, what can investors do to help prepare themselves for an uncertain inflation outlook?

Don’t waste your time trying to figure out the “best” investments for inflation protection. Instead, consider owning the whole market at all times.

Here’s why we encourage you to own the whole market in your investment portfolio. Anything can happen at any time, with little notice.

At Edelman Financial Engines, our asset allocation strategies are designed to deliver across possible scenarios, not to attempt a guess at which one specific scenario may play out in the near future.

It is important to consider having a long-term strategy with a diversified portfolio as an inflation hedge, rather than gamble on what might or might not happen. For example, our client portfolios may own some stocks in areas that can benefit in an inflationary environment, and others in sectors that tend to benefit more in falling-inflation environments.

But diversification doesn’t just mean you should own lots of stocks. It also means you should own lots of different asset classes – like bonds and government securities– in addition to stocks.

With adequate diversification, you can help protect yourself from catastrophic losses if something goes wrong with a single stock or a single asset class.

Every day at Edelman Financial Engines, our financial advisors create diversified portfolios for our clients, built for all different types of inflationary environments. If you’d like us to do the same for you, contact us to schedule your free consultation.