Exploring inflation hedges: What is fact and what is fiction?

The stock market has performed poorly so far in 2022. At the end of September, the S&P 500 was down more than 24%. That being said, financial advisors all around the world are urging clients to stay invested, because jumping ship in a downturn can be detrimental to your portfolio.

If you take return data from the S&P 500 for the past 20 years, you will find that missing only the best 10 days would take your return from 9.52% to 5.33%. This means that a $10,000 investment would go from $61,685 (had you stayed on the ship) to a measly $28,260. That means you could lose $33,425 over a 20-year period if you missed only the 10 best days.

And here's the real kicker: seven of the best 10 days in this 20-year period were within just two weeks of the 10 worst days. That's why financial advisors do all they can to keep their clients from pulling out of their investments during market downturns.

When you add in the elevated inflation rate we've experienced this year, many investors have been tempted to jump to asset classes popularly known to hedge against either market volatility, inflation or both. The question is, do these purported safe havens actually hedge as advertised?

Gold

Gold has long been considered an inflation hedge. This is because gold often increases in value when inflation is on the rise. It also has a reputation for rising when equity markets fall. Although these can often be true, investors need to consider the downfalls of investing in gold.

Volatility plagues gold and other commodities. Despite both market volatility and inflation, gold is down 8.8% on the year. Looking back further, from 2011 to 2022 gold had an average return of -2.6%. This includes years like 2021 (up 27%), 2009 (up 19%), and 2007 (up 16%). Another problem that often occurs is investors usually buy gold when gold is already at its peak. Buying gold when you already feel inflation defeats the whole purpose of inflation hedging.

At the end of the day, gold has more volatility and has consistently returned less than equities over the last few decades. It's not the place of investors looking for a smooth ride.

Cryptocurrencies

In recent news, bitcoin has taken a huge hit since its peak in November. Record high inflation occurring simultaneously with the deep dive of cryptocurrency should be evidence alone that cryptocurrency is not an inflation hedge. Crypto investors are beginning to understand the volatility associated with the new form of currency. It's because of the volatility and clouded understanding of cryptocurrency's correlation and value, that the SEC has not jumped on the bandwagon.

A chart of the value of Bitcoin shows little pattern of reliable growth. Interestingly, Bitcoin does share a pattern with the dotcom and other bubbles we have experienced. Investors should understand that, until the crypto marketplace matures and stabilizes, investing in cryptocurrency should be considered more speculation than investing. The short life of cryptocurrency has yet to prove to be a reliable inflation hedge.

Sam Watkins, CFP® TrueNorth Wealth

TrueNorth Wealth is a zero commission, fee-only, financial planning firm. TrueNorth Wealth specializes in high-net-worth individuals. We offer academically sound financial planning, and we educate each client on what our investment philosophy is, and why. We take an active role in helping each client examine their tax bill each year and creating meaningful strategy to manage that tax liability. If you are looking for an exceptional advisor, call TrueNorth Wealth for a no-cost consultation, today! 801-274-1820

U.S. Treasuries

Treasury inflation-protected securities (TIPS) are a way for investors to lessen their exposure to inflation risk. TIPS are adjusted for inflation semi-annually. Rather than changing the interest rate, the par value of the bond is adjusted for inflation. These are only of limited use, however. One downfall to TIPS is that they aren't very tax efficient. Increases to par value are considered taxable income even though the increase didn't necessarily make it into your pocket. For this reason, many investors hold U.S. Treasuries in mutual funds or tax-deferred accounts. After you account for taxes, most investors' returns will still trail inflation because of that tax hit.

Series-I savings bonds are a better tool to combat inflation. Through October of 2022, savings bonds are yielding 9.62%. Series-I savings bonds are low-risk investments and during high inflationary periods, they are attractive places to stick cash because they have attractive yields that adjust to inflation. There are some limitations. An investor must hold the I-bond directly with the Treasury, the investment amount is limited to $10,000 per person and you can't cash out for at least a year. If you cash out before five years, you must give up the previous 3 months of interest. Currently, I-bonds are an attractive short-to-intermediate term investment

Stocks

In today's high inflation environment, there are precious few options to beat inflation short-term, with the year-to-date inflation rate around 8.3%. Despite this, a well-strategized financial plan can help prepare them to hedge against inflation in the long term. Historical data shows that stocks are often the best form of inflation hedge available to investors.

Dating back to 1926, the S&P 500 has returned 10.5% and inflation, dating back to 1926 has been around 3%. Conceptually, as the dollar buys less, purveyors of goods and services on average have the ability to raise prices over time to adjust to inflation. This means that the earnings of companies held in a diversified portfolio will naturally adjust to inflation over time, plus real growth as well. It is for this reason that we teach all our clients that the safest portfolios have a mix of both fixed income and equities.

Stay on the ship

John Ray said, "He that cannot abide a bad market, deserves not a good one." Although looking at your 401(k) statement or the receipt at the gas pump may send you into shock, remember the long-term goal and the bigger picture. Jumping ship when markets are down can be catastrophic to long-term investors, so take whatever defensive measures you need to, from not checking statements as often to hiring a fee-only financial advisor.

It's likely in the not-too-distant future, you'll be seeing the market hit all-time highs again and you can look back at these choices you make today and be glad you did.

To learn more or schedule a no-cost consultation, visit our website at TrueNorth Wealth or call (801) 316-1875

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