How to invest to profit from inflation — and 2 other strategies to try when prices are on the rise

"Your savings rate is an important piece of the puzzle as well — not just what you're investing in."


As the economy continues to recover from the effects of the Covid-19 pandemic, the rate of inflation is on the rise. Some experts, including Federal Reserve chairman Jerome Powell believe that this period of rising prices is temporary. Others, however, think the economy may be headed for another prolonged period of rising prices.

If that happens, it could be bad news for investors: Inflation dampens your investment gains and erodes the value of your savings.

If you're worried about inflation's potentially harmful effect on your portfolio and want to make adjustments to your holdings, experts say you have a few basic options. Here's what they recommend.

Buy investments to profit from rising prices

If you're a younger investor willing to take on some risk, you can not only protect yourself from inflation but actually profit from rising prices by investing in companies that stand to benefit. One way to do this is upping your exposure to sectors and industries whose companies can easily pass rising costs along to customers, especially if those customers have to buy those products or services no matter what.

"If you want to add an ETF you can definitely look at particular sectors, such as commodities, energy, and infrastructure" says Amy Arnott, a portfolio strategist at Morningstar. But beware: Single-sector bets can be risky. "You're buying a very specialized fund. They tend to be tricky for investors to use well because they're volatile and unpredictable," she says. "People have the tendency to buy and sell at the wrong time. Again, I'd recommend dollar-cost averaging and keeping it to a smaller percentage of your portfolio."

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Another newer, and increasingly popular, option is to invest in a fund specifically geared to benefit from inflation. Launched in January of this year, the Horizon Kinetics Inflation Beneficiaries ETF already boasts nearly $700 million in assets, making it one of the more popular choices among new ETFs this year, according to CFRA. The actively managed ETF seeks to invest in companies that directly or indirectly benefit from rising asset prices, and holds heavy allocations to financial services, basic materials, and energy firms.

The fund owes some of its popularity to clever branding, says Todd Rosenbluth, head of ETF and mutual fund research at CFRA. "The timing was astute. It always helps when you have a popular buzzword in your name," he says. "It's also been working. And the fact that it's currently the only product I'm aware of geared toward inflation beneficiaries makes it appealing."

If you're considering this or any inflation-related ETF that crops up, take a second to look under the hood before investing, says Rosenbluth. "The fact that these are transparent ETFs means you can investigate all of the holdings," he says. "That can give you a little more comfort investing in a fund that has a relatively short track record."

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How to hedge against inflation

For more cautious investors, especially those closer to retirement, the objective is to protect the assets that they've already accumulated against inflation's effects, says Rosenbluth. "The goal is to generate income without taking on inflationary risk."

For these folks, a popular option of late has been Treasury Inflation-Protected Securities: government bonds whose principal value rises alongside inflation. During periods of rapidly rising prices, a portfolio of TIPS theoretically outperforms U.S. Treasury bonds or indexes that invest heavily in them, such as the Bloomberg Barclays U.S. Aggregate Bond Index ("The Agg") — the main benchmark for U.S. bonds.

Lately, investors are seeing the appeal, having plunked $25 billion into TIPS ETFs in the first eight months of 2021 alone, according to CFRA. If you're predominately a stock investor, however, these may not be for you, points out Rosenbluth. "The idea is to shift some of your Treasurys or 'Agg'-based products toward TIPS to protect them from inflation," he says.

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For exposure to a wider array of investments that tend to hold up well during inflationary periods, consider a diversified real asset fund: "These are funds that have a combination of exposures to different inflation-sensitive assets," Arnott says. "They typically hold things like real estate, gold, TIPS, and commodities. These are all assets that tend to perform relatively well as inflation hedges."

Don't expect these funds to outrun the stock market over long periods, though: "You're not buying them to generate strong returns in every market," she says. "They're more of a hedge during bouts of unexpected inflation."

Because of the up-and-down nature of these funds' returns, you'd be wise to limit your exposure, she adds. "They can go through long periods of underperformance," she says. "If you're carving out a portion of your portfolio for them, I wouldn't go higher than maybe 5%. And think about dollar-cost averaging in."

The third option: Ignore inflation altogether

It's perfectly valid to ignore the threat of inflation altogether — especially if you're a young, stock-oriented investor. "When you're a young person in the workforce, you have a built-in hedge against inflation in the form of your paycheck, assuming you're getting annual adjustments to your salary," says Arnott. "And while stocks aren't a direct hedge, meaning in the short term they may or may not move in line with inflation, over the long term they should provide a good hedge against inflation risk."

Even in the short term, rising prices may not be a big worry, says Alessio de Longis, head of tactical asset allocation at Invesco Investment Solutions. "We see the rate of inflation beginning to decelerate," he says. "We expect to see inflation statistics going lower over the next 3 to 6 months toward a return to a more normal inflation environment."

Regardless what you think of the direction of inflation, making tweaks to your portfolio isn't nearly as important as consistently funding it, Arnott points out. "If you're concerned that future returns could be lower and that inflation could be higher, one of the best ways to prepare for that risk is to make sure you're saving enough toward retirement," she says. "Your savings rate is an important piece of the puzzle as well — not just what you're investing in."  

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