What to Invest in During Inflation

By Michelle Clardie on 01/15/2023.
Reviewed by Dan Gatsby .
In 2022, the US saw higher levels of inflation than we’d experienced since the 1980s. Consumers felt the pinch of rising prices at grocery stores, gas stations, and retailers nationwide. 

While a sustainable rate of inflation (somewhere around 2-3% per year) is a sign of a healthy, growing economy, the 7-9% we saw in 2022 places a strain on individual consumers and the economy as a whole. Suddenly, a dollar today can’t go nearly as far as it could just a year ago. 

If left unchecked, this level of inflation can lead to “hyperinflation,” a condition in which consumers expect prices to continue climbing, so they demand substantial wage increases from their employers, which causes companies to raise prices on goods and services further in an ugly cycle. 

To avoid hyperinflation, the Federal Reserve stepped in and raised interest rates sharply in 2022. By raising rates, the Fed hoped to discourage buyers from taking on loans, which would slow the flow of cash through the economy, and temper the rate of inflation. And this strategy is working, albeit slowly. The rate of inflation fell from its high of 9.1% in June 2022 to 7.1% by November 2022.

But we’re still a long way from reaching the more comfortable 2-3% we’re accustomed to. And many investors are wondering how to invest during this ongoing inflationary period. They want to know

In this article, we will give you seven of the best investments during inflation, as well as three of the worst investments during inflation. And we’ll break down the pros and cons for you. 

Let’s start with our list of the seven asset classes to invest in during periods of inflation.    

1. Commodities (Including Precious Metals)

Commodities are tangible assets that are likely to grow in value. Commodities are also “fungible,” which means that one unit is largely the same as any other unit of that commodity. Consider gold, for example. One ounce of gold is worth the same as any other ounce of gold. Or wheat, as another example; one bushel of wheat is exchangeable with any other bushel of wheat. 

The benefit of investing in commodities is that the value of the raw materials increases alongside the value of the finished goods made from those materials. For example, if the price of gasoline is on the rise, the value of crude oil is likely increasing as well. 

You can invest in commodities directly by purchasing the tangible goods from dealers and/or producers. Or, if you prefer not to handle the assets yourself, you can invest in funds (like mutual funds or index funds) that invest in commodities.

2. Treasury Inflation-Protected Securities

Treasury-Inflation Protected Securities (TIPS) are investment vehicles offered by the US Treasury, specifically to help investors protect the value of their money during periods of inflation.

With TIPS, the US Treasury adjusts the “par value” (i.e. the face value) of the security each year to reflect changes in inflation. While this can help you hedge against inflation, it doesn’t necessarily offer much in the way of growth. Consider TIPS a defensive, rather than offensive, investment maneuver. 

You also need to be aware that deflation can reduce the value of your TIPS. The Treasury guarantees that your par value will never fall below your original par value, but it is possible that the value at maturity could be less than it had been at other points during the holding period.

You can purchase TIPS through investment brokers or directly from the US Treasury.  

3. I Bonds

Similar to TIPS, I bonds (US Series I savings bonds) are government-issued securities designed to protect investors during periods of inflation. However, unlike TIPS, the par value of an I bond does not get adjusted; instead, the interest rate on the bond gets adjusted every six months to reflect current market conditions based on the consumer price index (CPI).    

As with TIPS, your initial investment in an I bond is secured by the government. You cannot lose your initial investment. But you could potentially miss out on better returns by going with this low-risk, low-reward investment option.

I bonds are available through investment brokers or directly from the US Treasury.

4. Consumer Staple Stocks

Not all stocks are well-suited to periods of inflation. Your best bet is to focus on “consumer staple stocks,” meaning stock in companies that produce goods that consumers will continue to need, despite the increasing price of goods. Companies that produce laundry detergent, toothpaste, and shampoo all fall into this category. These companies will pass their increased expenses onto consumers, who will pay the higher prices because they consider these items as necessities. 

You can choose individual stocks, or you can invest in a fund (like a mutual fund or index fund), which bundles stocks from multiple companies into a single stock, allowing you to instantly diversify your investment across dozens, or even hundreds, of companies.

5. Mortgage-Back Securities (MBSs)

Mortgage-backed securities are investment products secured by a package of home loans. When banks issue mortgage loans, they often package a group of those loans to sell on the secondary mortgage market. Entities like the Government National Mortgage Association (Ginnie Mae), the Federal Home Loan Mortgage Corporation (Freddie Mac), and the Federal National Mortgage Association (Fannie Mae) purchase these loan packages and offer shares to investors. By investing in an MBS, you earn a percentage of the mortgage payments made by homeowners. 

When inflation has been increasing, and the Fed is forced to raise interest rates, MBSs can be a sound investment because the rates of return will increase with the higher mortgage interest rates. Furthermore, MBSs are generally considered to be safe investments because the risk is spread among hundreds or thousands of homeowners, all of whom have a vested interest in continuing to make their mortgage payments on time. 

You can invest in MBSs directly with Ginnie Mae, Freddie Mac, and/or Fannie Mae. Or you can go through an investment broker. 

6. Other Collateralized Debts

Home loans aren’t your only option for leveraging other people’s debts as a hedge against inflation. You can also invest in collateralized debt obligations (CDOs), which are pools of consumer debts secured by other goods, including vehicles, RVs, and boats.

CDOs are riskier than mortgage-backed securities because the borrowers don’t have the same vested interest in other collateral as they do in their homes. But the rates of return can also be higher because interest rates on consumer goods are typically higher than interest rates on homes. 

The most accessible way to invest in a CDO (which can have high investment minimums) is to invest in CDO funds. Some exchange-traded funds (ETFs), for example, allow you to purchase shares of multiple CDOs the same way you would purchase shares in stocks on the stock market.  

7. Income-Producing Real Estate

Real estate may be the ultimate investment hedge against inflation. 

What happens to real estate during inflation? Well, first, home values tend to increase substantially during inflationary periods. This appreciation in real estate increases your net worth and positions you to make a tidy profit when you’re ready to sell your investment. Even more importantly, rents increase quickly during periods of inflation. Increased rents mean more passive income in your pocket as renters make their monthly payments. 

There are multiple ways to invest in income-producing real estate, including

  • Buying a rental property of your own.
  • Purchasing shares of a real estate investment trust (REIT), which is a company that invests in income-producing real estate and disburses a portion to the investors in the form of dividends.
  • Using real estate syndication to access high-value deals with professional project management at low minimum investment amounts. 

Worst Investments During Inflation

We’ve covered the best investments during inflation, now let’s consider the worst investments during inflation so that you know which investments to avoid. 

  1. Cash. Cash sitting in your savings account or under your mattress is simply losing value. The higher the rate of inflation, the faster the purchasing power of your money is diminishing.
  2. Fixed-rate bonds. Since inflation leads to higher interest rates, locking in a fixed-rate bond at the lower pre-inflation interest rates leaves you earning less on your money than you could with other investments. 
  3. Stocks in companies that profit from discretionary consumer spending. As inflation rises, consumers cut back on luxury goods and services. So companies that offer luxury products are more likely to see a dip in revenues, and shareholders are more likely to see a dip in the value of their stocks. 

Pros of Investing During Inflation

In addition to the standard pros of investing (financial security, financial freedom, etc.), there are a few specific pros of investing during periods of inflation, including

  • Protecting the value of your investment portfolio, 
  • Diversifying your assets, and 
  • Preserving your buying power into retirement. 

Cons of Investing During Inflation

All investments inevitably come with some potential drawbacks as well. The primary con of investing in general is the risk of losing some of your capital on a poor investment. The cons of investing during inflationary periods include

  • The risk of allowing short-term market conditions like inflation to distract you from your long-term investment goals and 
  • Risk of overloading your portfolio on investments designed to beat inflation, leaving yourself exposed when the market returns to normal. 

Real Estate Investing to Beat Inflation with Gatsby Investment

Whether you’re specifically looking to beat inflation, or you’re generally looking to make smart financial moves under any economic conditions, it’s always a good time to invest in real estate. The reliable appreciation, cash flow potential, and tax benefits of real estate make it a valuable asset class for every investor. 

And Gatsby Investment makes real estate investing easy and accessible! With Gatsby, you can choose from short-term options like fix-and-flips, as well as long-term wealth-builders like multi-family rentals. With low minimum investment requirements and expert management of each project, you can minimize risk while maximizing return potential!

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