Which Investments Offer the Hope of Outpacing Inflation?

Inflation refers to a broad increase in the prices of goods and services over time, meaning each unit of currency buys less. This economic phenomenon reduces purchasing power, directly impacting savings and investments. Therefore, seeking avenues that can preserve or grow wealth in real terms is important.

Maintaining purchasing power is a financial goal, especially for long-term planning. If investments do not generate returns exceeding the inflation rate, an individual’s financial position diminishes. Understanding investment strategies that aim to outpace inflation is key for financial stability and growth.

Equities

Investing in equities, or stocks, offers a pathway for outpacing inflation over extended periods. Companies can increase revenues and earnings, translating into higher stock prices and dividend payments. This growth often aligns with or exceeds the general rise in prices.

Over the long term, the stock market has historically generated returns that surpass inflation rates. As businesses expand, they adjust prices to account for increased costs, passing inflationary pressures to consumers. This allows companies to maintain or grow profitability, supporting stock valuations.

Many companies distribute profits to shareholders as dividends. These payments can provide an income stream that adjusts upwards as corporate earnings grow in an inflationary environment. Companies with strong cash flows are considered resilient.

For many investors, a diversified approach through equity index funds or exchange-traded funds (ETFs) offers accessible exposure to the stock market. These funds hold a wide range of stocks, spreading risk and capturing overall market growth. This diversification helps investors participate in the potential of equities to outpace inflation without requiring individual company analysis.

Real Estate

Real estate is a tangible asset that can serve as a hedge against inflation. Property values and rental income tend to increase as inflation rises, helping preserve purchasing power. This is because construction materials and labor costs, which rise with inflation, directly impact property values.

As prices increase, landlords can adjust rental rates upwards, particularly for properties with shorter lease terms. This adjustment helps property owners keep pace with rising operating expenses and maintain net cash flow. Real estate represents a physical asset that cannot be devalued like currency, providing a store of value.

Investors can gain exposure to real estate through direct property ownership, such as purchasing physical properties. Another method involves investing in Real Estate Investment Trusts (REITs).

REITs are companies that own, operate, or finance income-producing real estate. They are traded on stock exchanges, providing liquidity not found in direct property ownership. REITs must distribute at least 90% of their taxable income to shareholders as dividends, making them attractive for income-focused investors. This structure allows individuals to invest in large-scale real estate portfolios without the complexities of direct management, benefiting from potential appreciation and income growth in an inflationary environment.

Inflation-Protected Securities

Certain securities offer protection against inflation, with Treasury Inflation-Protected Securities (TIPS) being a primary example. These U.S. Treasury bonds are backed by the U.S. government, making them a low-credit-risk investment. TIPS protect investors from purchasing power erosion caused by rising prices.

The principal value of a TIPS bond adjusts periodically based on changes in the Consumer Price Index (CPI), a common measure of inflation. When the CPI rises, the principal value increases; if deflation occurs, it decreases. This adjustment ensures the bond’s underlying value keeps pace with inflation.

Interest payments on TIPS are calculated based on this adjusted principal value, not the original face value. As the principal value increases with inflation, semi-annual interest payments also rise, providing a growing income stream during inflationary periods.

At maturity, investors receive either the inflation-adjusted principal or the original principal, whichever is greater, ensuring the initial investment is protected. The annual increase in the principal value of TIPS, even if not received until maturity, is considered taxable income by the Internal Revenue Service (IRS) in the year it occurs. This “phantom income” can create a tax liability without a corresponding cash distribution, leading some investors to hold TIPS in tax-advantaged accounts like IRAs.

Commodities

Commodities, raw materials such as gold, oil, and agricultural products, can act as a hedge against inflation. Their prices increase during inflationary periods because they are fundamental inputs for goods and services. As the cost of finished goods rises, so too can the prices of raw materials.

Higher energy costs or increased demand for agricultural products can contribute to broader inflationary pressures. The value of these commodities tends to rise, helping offset diminishing purchasing power. Commodities can also be seen as a store of value, especially precious metals like gold, which retain value when traditional currencies decline.

Investing in commodities can take several forms. Direct ownership involves acquiring the physical commodity, such as gold bullion, but comes with storage and security considerations. Another approach involves futures contracts, agreements to buy or sell a commodity at a predetermined price on a future date.

For many individual investors, a more accessible way to gain exposure to commodities is through commodity-focused ETFs. These funds invest in a basket of various commodities or their related derivatives, providing diversification and liquidity. While commodity markets can be volatile, their potential to appreciate during inflationary times positions them as a tool for investors seeking to maintain their wealth in real terms.