With inflation reaching multi-decade highs recently, investors are re-evaluating their portfolios to account for rising prices. Certain investments tend to perform poorly during inflationary environments, while others hold up better. This article examines the worst investments to own when inflation is high, along with suggestions for less risky alternatives. Key factors like interest rates, economic growth, and asset type all play a role in determining inflation winners and losers. By understanding how different assets respond, investors can aim to mitigate inflation risks. With proper preparation, it is possible to construct a portfolio resilient to even the highest inflation rates.
Cash and savings lose purchasing power rapidly during high inflation
Holding cash or keeping excess funds in a savings account can be one of the worst moves when inflation is elevated. As the prices of goods and services rise faster than interest earned on cash deposits, the buying power of that money steadily erodes. Even an FDIC-insured savings account earning over 2% interest will still see real returns decline as inflation exceeds that threshold. The loss of purchasing power happens slowly over time, but can devastate savers in the long run. Even risk-averse investors should consider some allocation to assets with potential to outpace inflation.
Fixed-rate bonds suffer declining real yields
Bonds paying a fixed interest rate are another asset that can lose value during inflationary periods. If a bond pays 3% annual interest but inflation rises to 5%, the real return for investors is negative 2%. The fixed payments will buy less and less over time as prices rise faster than the interest earned. Short maturity bonds minimize this risk, but still expose investors to losses from inflation outpacing yields. Treasury Inflation Protected Securities (TIPS) offer some defense as the principal adjusts upward with inflation. Holding at least a portion of a bond portfolio in TIPS can help offset inflation risk.
Stock markets have mixed performance, with high volatility
The stock market’s performance during inflation is far from straightforward. Equity returns have been positive in some periods of high inflation, while strongly negative in others. Stocks can benefit from rising consumer demand early in an inflationary cycle, but higher prices combined with rising interest rates often drag down earnings over time. Since different sectors of the market respond differently, stock investors should emphasize companies with pricing power and minimal debt exposure. Oil producers and gold miners often outperform the broad indexes, while consumer discretionary stocks struggle along with fixed-rate bond proxies like utilities.
Real estate gains are uneven based on asset types
Real estate is commonly assumed to be a strong inflation hedge, but not all properties perform equally well. The costs of residential real estate like single family homes tend to rise in sync with consumer prices. Rental income may lag behind for existing leases however, pressuring returns. On the other hand, commercial real estate including warehouses tied to economic activity can sustain higher rents during inflation booms. REITs are one simple way to add real estate diversification, but be selective in identifying the sectors with best inflation protection.
Inflation creates clear winners and losers across the investment landscape. By tilting portfolios away from cash, fixed-rate bonds, and volatile equities, investors can aim to mitigate purchasing power loss over time. Assets with adjustable cash flows tied to economic growth tend to provide better inflation-resistant returns. Maintaining diversification and avoiding drastic portfolio changes is key to navigating high inflation environments.