The U.S. Bureau of Labor Statistics reported that inflation was up 5.4% for the year through the end of July, the highest rate in 13 years. While the Federal Reserve thinks that the current surge is temporary, they have underestimated the recent surge in prices and may well be wrong about the duration of these higher rates. With Congress spending trillions more dollars and the Fed continuing to print money at a record pace, there’s no effort to rein in rising prices today.

In the 1970’s, the cost of living doubled with inflation averaging over 7% for the decade. For investors, their portfolio needed to double, after taxes, just to maintain its real value. While inflation always needs to be factored into investment returns and retirement planning, higher rates make it much more challenging. So where should you be investing in this inflationary environment?

Gold

Gold has a historical reputation as a good hedge against inflation. The correlation came about in the 1970’s when the US went off the gold standard, inflation surged, and OPEC raked in huge profits by raising the price of oil. The Arabs put much of their newfound wealth into gold rather than the depreciating US dollar and gold prices soared from the fixed $35 an ounce to a peak of $850 at the beginning of the 1980’s. Since then, gold has sometimes surged when inflation fears creep up, but there’s been no consistent rise in gold prices.

Today, the price of gold is almost exactly where it was ten years ago, yet the cost of living has risen by over 20%. Over the past year inflation has surged, yet gold is down nearly 10%. So gold, which pays no dividends or interest, is probably a poor investment choice even with soaring inflation today.

Bitcoin

The cryptocurrency fans have suggested that the fixed amount of “currencies” like Bitcoin would make them a good inflation hedge. But a look at the wild fluctuations in their prices don’t show any meaningful ties to the cost of living. Over the past four months as inflation figures have soared, the price of Bitcoin has fallen, still down about 30% from the April peak.

Bonds

Today, the yield on a US Treasury bond that matures in ten years is about 1.3%. That’s 4.1% below the recent inflation rate even before taxes. While inflation may moderate, the 1.3% yield is well below historical rates of inflation so bonds are unlikely to even keep up with inflation, never mind make a good investment. And, if the Fed finally raises interest rates to fight inflation, bond prices will fall, creating losses for investors that don’t hold the bonds until maturity. For more on bonds, see last month’s blog post, Bonds: Worth the Risk?

Stocks

When you think about stocks, you need to go beyond the latest Dow Jones Industrials Average figure and consider the individual companies. Most companies will face rising labor and materials costs in an inflationary environment, but most will also be able to pass along those higher costs to their customers. Different companies and industries may face differing impacts but generally stocks can adapt and hold up well during an inflationary period.

As inflation rises, though, interest rates will typically climb as well. Higher borrowing costs are a negative for stocks and higher rates usually mean lower multiples (PE ratios) that will also negatively impact stock prices. While stocks aren’t likely to thrive with inflation, they typically hold their value better than bonds.

Real Estate

Real estate has always been considered a good inflation hedge and the correlation makes logical sense. As incomes and building costs rise, property prices will usually move with them. But real estate has other factors that impact their price as well. Individual property prices can vary significantly based on the location and type of property and the local demand. Financing costs are also a big factor, so rising interest rates in an inflationary environment can be a negative.

Real estate investors can diversify their holdings and dramatically reduce trading costs by using Real Estate Investment Trusts, or REITs, which invest primarily in commercial real estate. With inflation picking up and financing costs falling, REITs have weathered the economic impact of the last year’s pandemic and have gained about 30% over the past year. Like most assets today, their yields are near record lows so future gains are likely to be more modest, but they may well make a good investment to weather an inflationary period. For more on real estate investing see our June, 2020 post Why Real Estate?