How to invest for higher inflation
Topping the worry-list for most investors these days is inflation.
How to combat inflation overall?
How to invest for higher inflation?
This post will share my thoughts including how I intend to fight higher inflation – inflation I expect to see for another year or so.
What is inflation? What does inflation matter?
What is inflation?
At the most basic level, inflation is an increase in the price of goods and services over time.
What does that mean for you and me?
An erosion of purchasing power…
In part articles on this site, I reflected on the inflation subject and found some stellar references.
Case in point: inflation on A Wealth of Common Sense.
In that post, Ben Carlson highlighted one of his favourite ways to combat inflation: the stock market.
“The stock market is a wonderful hedge against inflation for a few reasons. Since 1928, the U.S. stock market is up 9.8% per year while inflation has averaged 3% per year. So stocks have grown at nearly 7% more than the rate of inflation. One of the reasons for this is the fact that earnings and dividends also grow at a healthy clip above inflation. Over the past 93 years, earnings have grown at roughly 5% per year. Stocks also have perhaps the greatest income stream of any asset. Dividends have grown at roughly 5% per year.
So earnings and dividends both have a history of growing above the rate of inflation.”
Same thoughts here Ben. Complex problems can have some simple solutions. That said, things are more complex than that. It’s not just about investing in the stock market as one way to combat inflation. You might consider what stocks to invest in as a hedge.
Inflation is not all bad, is it?
Of course, you could argue some inflation is always very good. The economy is growing. Better than deflation. Deflation is associated with a shrinking economy and depressed times – less money in supply and therefore less money to spend.
- Inflation will hurt those who have a big bias to cash savings – should inflation continue.
- Retirees focused on fixed incomes might suffer.
- Borrowers who took on variable rates, and more…
- Inflation will benefit those with large debts who are on fixed repayment plans over variable.
- Owners of land or scarce physical assets (like land, materials, other).
- Firms that can raise prices, rather easily, without too much trouble or public outcry, and more…
But spiking or high inflation is not good for many reasons and it really depends on your age, investment timeline and of course, what you invest in to combat inflation.
Let’s take a quick look at who needs to really worry about rising inflation in my book.
The Working Class (Inflation Worry Level: High)
As I mentioned above, with higher inflation or inflation spiking, that’s a challenge for the working class. Beyond higher prices at the grocery store or other, I believe this an issue because of the relationship between inflation and unemployment has traditionally been an inverse correlation. Low inflation and full employment are the cornerstones of monetary policy for our central banks. Inflation can cause unemployment when:
- The uncertainty of inflation leads to lower economic growth.
- Inflationary growth is unsustainable/not well-managed (see today), and
- Inflation leads to a decline in competitiveness, lower exports, etc. causing unemployment.
A decent argument can be made when higher inflation rates exist, unemployment will move higher. Countries like Germany have been fairly successful as a model: they have enabled a long period of economic stability to support a long-term low unemployment rate. If inflation increases however, monetary authorities will tend to increase interest rates to reduce inflation. A sharp increase in interest rates can cause economic growth to fall, potentially leading to a recession and higher unemployment. Therefore, we may predict that after any economic boom rising inflation could follow.
In some periods, we have seen both falling unemployment and falling inflation. For example, in the 1990s, unemployment fell, but inflation stayed low.
Personally, going-forward, I’m a bit concerned that inflation is running hot as a worker. I don’t believe my wages are going to go up tremendously in the years ahead and that means with higher inflation, companies are going to need to and will want to – cut back. If inflation continues to run hot, and our Bank of Canada remains sitting on their hands, I think we’ll see some company layoffs occur.
Aspiring retirees and retirees (Inflation Worry Level: Moderate)
Like I mentioned at the start of this post – topping the worry list for investors including aspiring retirees or current retirees?
Questions related to inflation abound.
- Do I have enough to retire, to fight inflation?
- Will I run out of money in retirement?
- How much can I safely spend in retirement?
Many aspiring early retirees or current retirees worry about the value of their investments that might not keep up with inflation. Add on long-term, future healthcare costs and there are larger concerns for any retiree to consider.
The good news is in my view, it’s not all doom-and-gloom. Here are ways retirees as investors can help fight inflation:
First, continue to own more stocks than bonds. Like Ben cited above, given stocks, historically, have been able to pass forward some rising prices back to the consumer, I’m going to continue to own my basket of stocks (including my dividend paying stocks) for the long-haul.
When thinking about how to inflation-protect an investment portfolio, it’s useful to consider the following key buckets:
- Inflation-hedgers, and
When I think of some inflation-hedgers I think of REITs and commodities in particular, although other sectors can “win” for sure. Historically speaking, whether you are investing in real estate directly via your home, rental units, or owning publicly traded Real Estate Investment Trusts (REITs) like we do – owning real estate can be a nice hedge for higher inflation. Why? Home values and rents tend to rise during inflationary periods. I mean, people have to live somewhere… Owners of apartment buildings, shopping malls, and other real estate tend to push rent increases at times when inflation is running up, which in turn enhances REIT payouts to shareholders like me.
I would also consider owning commodities and raw materials as inflation-hedgers. Commodities are a broad category of things like oil and gas, grains, electricity, and other. Commodities and inflation have a unique relationship as you well know. Rising commodity prices are indicator of (more) inflation to come. As prices rise, so does production/manufacturing costs to turn materials into commodities that are bought and sold. So, you can already see by this simple explanation how owning commodities might be helpful.
On the subject of gold, I personally won’t own it as an inflation-hedge due to it’s lack of effectiveness. See below. A long-term chart of gold against the CPI (Consumer Price Index). From the article I read “You might first notice that gold has risen more than the CPI, but also notice how little correlation there is between the two.”
Second, retirees should make good use of your government benefits.
When it comes to our Canada Pension Plan (CPP) and Old Age Security (OAS), you should know both government benefits have inflation-fighting power built-in. So, when you decide to take these benefits is a MAJOR retirement decision.
On Cashflows & Portfolios, there is an excellent article about when to take your CPP benefits.
- CPP at age 60 – If you begin your CPP/QPP payments prior to age 65, you’ll incur a 0.6% reduction for each month you collect before your 65th birthday. This reduction works out to be 7.2% per year. If you begin collecting your pension at age 60, your total reduction will be 36% when compared to age 65.
- CPP at age 65 – this is the “standard” age to take CPP without reductions or penalties.
- CPP at age 70 – If you don’t need the money, if you delay your CPP/QPP payments, you’ll receive an increase of 0.7% for each month you wait after your 65th birthday. This amounts to an increase of 8.4% per year and can be up to 42% if delayed until age 70.
The CPP is adjusted annually based on the consumer price index, which is intended to offset inflation.
So, delaying CPP up to age 70 is one the best, guaranteed, inflation-protection decisions you can make as a retiree.
You should know you can receive a higher Old Age Security pension amount for each month you decide to delay your first payment. While you can receive your first Old Age Security pension payment the month after you turn age 65, you can receive a higher amount for each month you decide to delay your first payment.
You can delay payment of the Old Age Security pension for up to 60 months (5 years) after you are 65 – up to age 70. The longer you delay, the larger your pension payment will be each month. Some Canadians don’t know this fact: by voluntarily deferring OAS benefits until age 70, Canadians can increase their OAS payments by 36%.
OAS payment rates are reviewed quartely in January, April, July and October to ensure they reflect cost of living increases, as measured by the Consumer Price Index (CPI). For example:
- monthly payment rates will increase if the cost of living goes up
- monthly payment rates will not decrease if the cost of living goes down.
So, be very mindful of when you take these government benefits to get the adequate inflation-fighting power when you need it the most, in your senior years.
Current investors in their asset accumulation years (Inflation Worry Level: Low)
As an investor striving towards semi-retirement in a few years, it’s not like I don’t think about inflation. I do, see this post today!
Rising inflation will likely hurt most growth stocks (think the tech sector) for example. But, as I have written about above higher prices can result in higher interest rates, which can lower the appeal of growth stocks compared to less risky alternatives, and make them a good time to buy.
If inflation continues to run hot, with a frothy broad stock market filled with 25% tech stocks like the S&P 500 is, I could see these tech stock prices coming down – fast! You could argue any tech risk in the S&P 500 is much higher now than in any tech bubble. So, buyer beware.
This is why I keep some cash handy as part of my cash wedge – you should too!
Back to my inflation-beaters comment, while I cannot predict the future, I continue to see value stocks in particular “beating inflation”, so it’s important to stay invested in these stocks during periods of higher inflation.
More on that from Ben Carlson here.
Beyond value in general, there are some sectors I really like or approaches I really like: companies with a history of increasing their dividends may provide a measure of inflation protection. So, this is part of the reason why I’ve always owned a basket of dividend-paying stocks in my portfolio. Dividend-paying stocks have historically demonstrated higher-quality and less volatility than the broad market.
This makes my hybrid approach to investing and income generation for semi-retirement rather predictable.
When it comes to owning certain stocks in your portfolio, I would personally recommend you look at your exposure to growth stocks with higher inflation here – and not be “all in” on tech stocks like I mentioned above. Tech stocks in particular may perform poorly because they expect to earn the bulk of their cash flow in the future…as inflation rises, those future cash flows are worth less. This is not to say that will happen to those companies, but it could.
Check out how some U.S. equity sectors have performed related to inflation here:
Based on my thesis above, you’ll find the following sectors should help fight or beat inflation:
- Consumer staples (think products you buy or use every day)
With inflation here, you may consider these approaches to generate retirement income.
I have no idea how long inflation climbs might be, at what level and when inflation might top out, what the impact inflation will or will not cause to our broader economy.
I would say as DIY investors we need to continue to embrace wealth builders and focus on what we can control: amount, time and rate of return. Added together, more money, more time to compound/grow and higher rates of return are ideal for us to combat inflation.
I would remain mindful but avoid obsessing about taxation or inflation in general. While unnecesary taxation should be avoided of course, inflation is something out of our control. It can be managed to an extent as we progress through our respective investing journeys.
Inflation is just one more reason why it’s important to have a well-diversified portfolio. If your investments are spread across different asset classes, geographies and sectors I think you (and I) can weather any inflationary storm. You should consider value stocks, dividend paying stocks, REITs and more to help you fight inflation. You should likely avoid keeping too much cash on the sidelines since current bank/savings rates of return are not likely to keep up.
Essentially, make sure you have a clear game plan for near-term expenses with long-term investment focus. I’ll keep you posted on my plan.
How are you fighting inflation? What are you owning? Are you simply cutting back spending instead? Do share in a comment!
How much cash should you keep? How much do I intend to keep?
Why would anyone own bonds now?
Here are some lessons learned in my investing journey when it comes to diversification. I hope they can apply to you too!
Mark and to all who shared on the inflation way a head. I’m also diversified in my portfolio. I am 66, when I was younger mutual sales people stated “don’t worry invest for the long term” MERS, yeah. I educated myself through you Mark and your kind learned sharing folks. I hope younger people can realize how important self financial information will affect their future. One point I would like to acknowledge is CPP/OAS and if you can delay them. They are inflation fighters. Thanks Mark.
Great stuff Fred. Yes, I hope to delay CPP to age 70 although I may take OAS at age 65, we’ll see. Those MERs via high-cost funds can be a killer and buyer beware for sure!!
Best wishes on your inflation fighting progress in 2022 as well 🙂
Inflation is a real issue that we will face for a long time. There are a lot of good points here about how to protect our investments against inflation. But what is generally overlooked in these discussions is the effect all the government handouts are having. Countries that have their own fiat currency don’t run out of money, they just create more. This notion that the debt of our country is something future generations will have to pay back, is false. Governments put money into the economy to stimulate growth, and then take some of it back in taxes. the deficit of the government is the surplus of the people that receive it. As long as our irresponsible governments don’t get that balance right, we will have inflation. Too much cheap money looking for a limited supply of goods drives up prices. Interest rate increases and higher taxes will help. But the money supply also has to be dialed back. We can’t continue to give incentives not to work.
Great points and I’ve been concerned for many years now about gov’ts simply printing money to stay ahead. It makes no sense to me and becomes very irresponsible money management. I don’t see our government haivng much if any fiscal responsibility. Our tax system is a bureaucratic mess. There are many opportunities to streamline, consolidate and improve but I don’t see any of this coming. The government is only interested in votes and their thinking is very short-term. Child-like at best.
Thanks for your comment and I could go on and rant more 🙂
Yes, I would like to rant more about our government as well. But it doesn’t do any good. Your right, they do whatever gets them more votes. Sober second thought, what is that?
Investors like us are a lot better off then the average person in this country that has to pay for ever increasing prices. I too could go on, but…………..
I hear ya. Negative energy is not good energy!
Is this still your entire portfolio? 🙂
Best wishes to you in 2022, stay in touch,
No, this is a sample portfolio that I would recommend for someone getting started. I have 32 companies in my portfolio. Which includes some QQQ, BRK.B, and Allspring Multi-Sector (XNYS:ERC). The rest are all individual equities that pay dividends. You can read a lot more about what we have here https://dividend-cafe.com/dividend-investment-income/
Makes sense – own QQQ for the same reasons you do and many BTSX CDN stocks as well – for the same reasons!
Interesting post. I revised my plans last year and decided to defer CPP/OAS to age 70 (me) and 68 (wife), in about 4 1/2 years. This will give us roughly 53k in inflation protected “guaranteed” income (such as it is) through our 70s and 80s, providing a inflation protected base line. I have a fixed DB pension, which will shrink with inflation, and an investment portfolio that I have concentrated in utilities, REITs, MICs etc, so there will be some inflation protection there. I’ve cashed out a couple hundred K and put it in EQ Bank RRSP savings accounts as a CPP/OAS bridging fund, which pay 1.25 points, way better and safer than money market investments for cash. We’ll draw that down until taking CPP, and I’ll allow a 5% annual inflation adjustment in the drawdown plan. We still have roughly 600k in dividend investments, generating about 35k in cash flow. So our total income will be somewhere around 115-120k, with 2/3rds of it guaranteed, and one third exposed to market risk, with at least a minimum base line, a little under half, as government inflation protected income. In a worst case scenario where our investments drop 2/3rds, our income would decline to the low/mid 90k range, quite tolerable. This plan lets me sleep at night, as long as the Feds don’t go bankrupt. You should have gold, around 5-10%. Gold is less of an inflation hedge or spec play than it is basic portfolio disaster insurance; it’s the final refuge when everything tanks. I’m at 15% because I foresee a bigger disaster coming than most people. Most of my gold is HGY, which writes calls on GLD shares and generates a nice cash flow of 6-7 points from call premiums. The rest is Sprott. Actually, in spite of the inflation worry and hedging, I think the future beyond the next couple of years is deflationary (humanity is shrinking, and technology is exploding, both extremely deflationary forces).
First, I hope to defer CPP myself to age 70. I just like the fact that you have higher income from CPP and it’s inflation-protected.
Second, I’m biased, but I think your concentration or at least holdings in utilities, REITs, MICs etc, provide inflation-fighting power. Having 600k in dividend investments, generating about 35k in cash flow, is outstanding to go along with any pension.
Interesting call about gold but I could see that as a disaster hedge moreso than any inflation play. I would rather own those utilities and REITs myself!
What do you make of interest rates to combat John, should they go up and why not already? 🙂
Thanks for your insightful comment,
Yes they need to “normalize” at 3-5%. Money rents way too cheaply. If I was king I would let rates creep up incrementally over several years. Problem is the Liberals can’t let that happen. They are in a Chinese finger trap, having returned us to the regime of the father of the current nitwit, in the mid 80s, when wild spending by Marc Lalonde plus interest rates of 10% had the feds spending a quarter of tax revenue servicing debt. Now they are in the same boat and all interest rates have to do is go to 3 or 4% to create the same fiscal crisis. Basically, we are ruled by incompetent fools and are farked. Central banks have less control over all this than you might think, actually way less. The number one guru on macro, central banking and the Eurodollar system is a guy named Jeff Snider, a guy who has read FOMC minutes from the 70s and knows the real history like nobody else. This series of interviews with Robert Breedlove is probably the best short and sweet education on the banking system, reserve banking, the Eurodollar system, and the roots of the 2008 crisis. https://www.youtube.com/playlist?list=PL2jAZ0x9H0bR7K5mlncgcR1DujGsA0Ob8. Watch them all for a real monetary education.
I also follow his podcasts with Emil Kalinowski https://www.youtube.com/results?search_query=emil+kalinowski
Totally agree with the “normalize” comment John – I would be fine with that range myself = 3-5%.
Now the central banks are in a corner – did it to themselves – they lowered rates too low for too long. It’s a mess IMO!
Great read, Mark. Can’t beat a high-quality, diversified portfolio with a leaning toward dividend growth. Works in every market environment.
Nice points on the potential gains for retirees to wait for OAS/etc. payments.
Thanks very much. How are you guys investing in 2022?
What a great article, Mark. You hit all the major points right on.
To fight inflation, I think it’s good to invest in top quality stocks that can yield high margin earnings and income. Right now, sectors like energy and REIT’s are showing great promise. All the energy companies, with oil prices around U.S. $80/barrel, are drowning in pools of high cash flows. This will benefit investors as companies are paying out higher dividends or buying back their own shares that result in higher earnings and income. Even high quality tech stocks, like Apple and Microsoft have tons of cash sitting aside and don’t know how to spend it. These tech stocks should do well even if inflation is not transitory.
If you want to take higher risks, one can look for penny stocks. The latter can reward risky investors with higher returns. Of course, one should be able to stomach the high volatility that comes with it. The other sector that can reward handsome returns is crypto currencies. Here again, the volatility is so unpredictable. Only invest in what you can afford to lose.
Inflation is a double-edged sword. One should be careful where to spend their hard-earned money. Tread carefully on any financial journey and, in the end, we will come out richer than you think!!!
Good luck everyone.
Yes, energy and REITs are likely to benefit in 2022. I will also keep owning QQQ for my tech stocks, I figure it’s < 5% of my portfolio anyhow and I also own the U.S. index. I think some higher level of inflation is here for another year at least. The market will do what the market will do - best to have a bit of everything but I'm long for stocks and I hope I will be rewarded in the coming 2-3 years as I approach semi-retirement. 🙂 Keep ya posted on the site! Mark
Great points Mark. Dovetailing some of our discussions on Twitter, it seems the best way to fight inflation is to buy a home; you get high leverage, and can have a fixed interest rate. That’s a 1-2 punch against inflation. Maybe it’s why so many have gone house crazy as of late.
Ya. For sure. Rates are stupid low for ridiculously too long and coupled with low housing supply and very high demand, that is the madness I believe. So, can’t do anything about supply right away but they (BoC) can raise rates and should. This is getting stupid IMO.
Agree. Perma low rates is nuts. It’s driven housing to insane levels, govt & personal debt mountains, and also driving TINA and rocketed markets higher. Distortions of epic proportions.
Increasingly risky for Canadians. The way out seems ugly, but what do I know.
Yes. I believe central banks and at home our BoC have lost all control. None of this makes sense to me how they are not trying to reign in some inflation. 25 basis points would be nothing to hike in the coming weeks but it would be a nice signal for a change. I think our governments are basically out of tools and really don’t care too much about any fiscal responsibility. Actions speak louder than….
I will continue to invest in dividend paying stocks because I will need to get paid in semi-retirement soon.
The way out does seem very ugly and painful on the taxation front. I don’t see any other way if rates don’t rise and go up 100-200 basis points in the coming years. That would be good.
Agree. The economy is hot, labour is hot, housing, inflation etc etc. We’re overstimulated.
Yep. No one wants to stop the train and face the music. Look at those housing charts/stats I reposted on Twitter. Oh my.
I need to get paid too, as a retiree without pension right now. Alternatives to dividend paying equities have been removed as reasonable options. IMHO, that’s not good.
Pain from taxes yes but the pain of bursting bubbles is much more concerning to me.
Rock on I guess.
Yup, debt orgy and everyone thinks real estate and markets go up forever, in a pandemic no less, when governments are broke. So many things not right.