The annual inflation rate hovered below 2.5% for the entire 2010s, but it increased to over 5% in summer 2021 is likely here to stay. Average costs are rising significantly for the first time in many people's investing careers, and some investments will respond better than others. By following these three tips, your portfolio will be ready for continued inflation throughout the 2020s.
1. Pick stocks that benefit from inflation
Behind every stock, there is a company with a business model that inflation impacts differently. Companies that will benefit from inflation can successfully pass their costs on to the consumer, such as Apple or Amazon. People are still lining up to a buy new iPhones and ordering things on Amazon Prime, and these megacap companies don't feel the woes of inflation like others.
For those who want access to stocks but are concerned about high volatility, two sectors generally respond well to inflation. Basic materials companies provide the world with what they need, whether it's through manufacturing, mining, paper, chemicals, or metals. Consumer staples stocks are items that consumers will continue buying during a recession, such as food, beverages, and household products.
One company that stands out in this space is Costco (NASDAQ: COST), which uses its Kirkland brand to manufacture goods affordably, enabling lower customer costs and maintaining 90% customer loyalty. With 100 million memberships and a growing online presence, it is well positioned for a higher-inflation environment. Costco can keep costs relatively low, and customers will likely remain loyal through modest price increases.
In contrast, earlier-stage companies can have a tougher time. They often are spending generously to acquire users and focusing on long-term growth before profits. These companies must now pay higher prices for the same services, and may not have earn sustainable revenue to grow as they would when inflation was under 2%.
The gaming-meets-gambling company Skillz (NYSE: SKLZ) is down 50% off its peak earlier this year. It is still in customer acquisition mode, and the company reported an $80 million loss last quarter, four times larger than a year before. While the company still has long-term growth potential, it is facing an uphill battle in the short-term since it must spend to acquire customers, and faces higher prices with inflation.
2. Invest in other asset classes
Outside of traditional stocks, there are plentiful opportunities to hedge your portfolio. Traditionally, gold often performs well during high inflation. Because the supply of gold increases slowly, the price rises when investors flock to the safe haven asset. Because most people won't buy physical gold, the SPDR Gold Trust ETF (NYSE: GLD) is a popular, relatively inexpensive way to buy it.
Investors have started picking a less traditional hedge too in cryptocurrency. Using the same logic around a finite supply, cryptos may increase in demand as investors look for uncorrelated investments to the rest of their portfolio. While the low risk of stablecoins may sound appealing, those will lose purchasing power with inflation as the US dollar to which their price is pegged becomes less valuable. While volatile, a small allocation to Bitcoin (CRYPTO: BTC) or Ethereum (CRYPTO: ETH) serves an uncorrelated hedge to a stock portfolio, with larger potential to appreciate than gold.
3. Buy TIPS instead of fixed-rate bonds
High inflation significantly weakens your purchasing power -- how much your money can buy. While fixed rate bonds and CDs offer safety and little risk for your savings, they can't keep up with high inflationary environments. Investors holding onto these bonds will lose purchasing power, since whatever these investments pay in interest will probably remain well below inflation.
A nice alternative is buying TIPS instead of traditional bonds. As the "Treasury Inflation Protected Securities" name suggests, these bonds adjust their coupon payments to protect investors from inflationary risk. With inflation coming back, these are a better choice than fixed rate investments.
Higher inflation is coming, but you shouldn't view it as a cost. It's an opportunity make sure your portfolio has uncorrelated investments that can perform well during inflation. Examine and diversify your portfolio, ensuring that each position can withstand high inflation and is uncorrelated to your other investments. Whether you're buying public stocks or a nontraditional investment, you can find great choices that are poised to profit over the next decade.
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Fool contributor David Smith owns shares of Apple, Amazon, Skillz, and Costco and has a position in Bitcoin. John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. The Motley Fool owns shares of and recommends Amazon, Apple, Bitcoin, Costco Wholesale, Ethereum, and Skillz Inc. The Motley Fool recommends the following options: long January 2022 $1,920 calls on Amazon, long March 2023 $120 calls on Apple, short January 2022 $1,940 calls on Amazon, and short March 2023 $130 calls on Apple. The Motley Fool has a disclosure policy.