How to invest for an increase in inflation

Bonds are the tradtional 'loser' during inflation, as well as cash, but at this moment in markets, cash has been a big winner. The question, as you accurately see it, is what to convert the cash into if inflation is around the corner.

One obvious home for your inflation-proof money is a home (literally :-) Housing prices are well off their highs, some think they may have bottomed, and a home is a very big-ticket, inflation- sensitive item with immediate personal utility.

If you have all the real estate you want, my next bet is stock in a company with products or services that are either best-in-world or not easily imported. By purchasing part of "the establishment" you have an inflation hedge. By purchasing increasing sales and earnings, as well as possibly increasing dividends, you have a "kicker." You have an income stream, and the AICPA definition of liquid assets.

Gold is usually highlighted (as if the shiny-yellow needed highlighting :-) and if you can justify the holding and transaction costs, I suppose gold or silver are good for retention of value, but be very mindful of your market timing.

I think the idea behind inflation hedging is to hold "real value" (that which money buys), as opposed to "buying money." Make sure you keep cash for expenses :-)

TIPS, gold/precious metals, materials, real estate.

One way is to buy real estate investment trusts (REITs). Landlords raise rents in times of inflation, so REITs are an effective hedge. Buy the equity type, not the mortgage type. One simple way is through the Vanguard Equity REIT index mutual fund. REITs are depressed right now (aren't we all), but recovering.

Over a long enough time, buying a stock market index fund, should decently keep up with inflation.

You can get close to keeping up with inflation in a risk-free fashion using TIPS (in an IRA or taxable account) and i-bonds (in a taxable account). If you are looking to beat inflation, you'll need to take on more risk with no guarantee that it will pay off - see other replies for various suggestions.

If buying TIPS, look at buying individual bonds because the expense ratio of mutual funds will cause you to fall further behind on tracking inflation.

Anoop

As you said, only buy TIPs in an IRA or other tax-deferred account.

As far as expenses, Vanguard's TIP index fund charges 0.20% as does the iShares TIP ETF. Vanguard's institutional class on their TIP fund (which may be available in one's 401k) charges only 0.08%.

Swedroe's book on Alternative Investments has an excellent brief chapter about TIPS and iBonds, some strategies for managing them, and some notes about their correlation (or lack thereof) with equities.

I think the evidence for that is kind of weak. Certainly in the 70's, stocks kind of stumbled along. They didn't come close to keeping up with inflation. At least one reason then is that P/E ratios contracted. I think some of that was just part of the secular cycle, but some of it was increased discounting of future earnings, partially driven by high interest rates.

The market didn't take off until inflation got under control in the early '80s.

-- Doug

I think that the general stock market should be a good hedge against inflation. Many companies are leveraged which will increase their return in an inflationary environment.

-- Ron

Over longer stretches, equities form a pretty good hedge against inflation, inasmuch as their inflation-adjusted return has been higher than other asset classes.

However, in shorter ones, just when inflation heads up, they stink. (ie. consider the inflation spike in the late 70s/early 80s -- and how equities did over that same period). To balance this out, one might consider an asset class which has a relatively low correlation with equities and which performs well during inflation spikes. Probably the purest such asset class is TIPs. Exposure to both TIPS and equities should help ride out bouts of inflation, both as it heats up and over the longer run.

(Note, of course, to keep the TIPs in an IRA or similar account)

TIPS.

TIPS are fine in a taxable account as a hedge. If the US$ collapses, might as well put the gun to your head as world travel is restricted for new residence.