As the United States adjusts to the recently unfamiliar and always unwelcome emergence of inflationary pressures, investors may seek opportunities designed to help protect capital from losing ground to the creep of inflation.
What Is Inflation, and How Do You Hedge Against It?
Inflation, simply stated, is the rate at which prices for goods and services increase. As prices rise, the ability of individuals and companies to buy things (often called purchasing power) drops. The U.S. Federal Reserve targets an inflation rate at or below two percent annually. Over the past twenty years, the pace has stayed very close to that benchmark, thanks at least in part to active management by the central bank. However, the Wall Street Journal recently reported that consumer price inflation in November reached 6.8% over the same month in 2020 (with core inflation at 4.9%).
While the Fed may endeavor to "cool down" the economy, the risk of inflation may also lead investors to consider options to help hedge their portfolios against inflation. In basic terms, hedging against inflation means buying an investment with a value related to the level of price changes. Real estate and commodities have traditionally been considered hedges against inflation. Commodities like gold and silver haven’t been prone to sharp value changes, which may make them attractive to investors looking for possible stability.
Hedge Efforts Include Exchange-Traded Funds
Exchange-traded funds that specialize in inflation-resistant bonds are intended to protect against the effects of rising prices by including TIPS (Treasury inflation-protected securities) in their fund. However, if interest rates rise, these funds may not achieve the desired gains. According to the WSJ, some funds are taking the "spaghetti on the wall" approach, loading up with a little of everything to spread risks and manage volatility. These funds may include stocks in the energy, industrial, and financial areas, plus REITs, commodity ETFs, and bonds.
Are REITs a Good Inflation Hedge?
A REIT (Real Estate Investment Trust) is a company that owns and operates or finances real estate assets. The REIT combines capital raised from investors to acquire and manage commercial real estate while the individual investors seek the benefit of passive income without actively managing property.
You can buy and sell most REITs like stocks on public exchanges, making them very liquid investments. REITs seek to provide investors with both steady income and tax advantages. To qualify as a REIT, the company must adhere to rules that include the composition of its assets, the source and distribution of income, number of shareholders and concentration of shares, and more.
Like direct real estate investments, REITs may have the potential to be attractive hedges against inflation. But also, like direct ownership, REITs have risks and may lose value. Therefore, every investor must consider their particular risk appetite and determine which hedges are acceptable and appropriate.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation. The actual amount and timing of distributions paid by programs is not guaranteed and may vary. There is no guarantee that investors will receive distributions or a return of their capital. These programs can give no assurance that it will be able to pay or maintain distributions, or that distributions will increase over time. A REIT is a security that sells like a stock on the major exchanges and invests in real estate directly, either through properties or mortgages. REITs receive special tax considerations and typically offer investors high yields, as well as a highly liquid method of investing in real estate. There are risks associated with these types of investments and include but are not limited to the following: Typically no secondary market exists for the security listed above. Potential difficulty discerning between routine interest payments and principal repayment. Redemption price of a REIT may be worth more or less than the original price paid. Value of the shares in the trust will fluctuate with the portfolio of underlying real estate. There is no guarantee you will receive any income. Involves risks such as refinancing in the real estate industry, interest rates, availability of mortgage funds, operating expenses, cost of insurance, lease terminations, potential economic and regulatory changes. This is neither an offer to sell nor a solicitation or an offer to buy the securities described herein. The offering is made only by the Prospectus. Exchange-traded funds are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from the Fund Company or your financial professional. Be sure to read the prospectus carefully before deciding whether to invest. Alternative investments, including hedge funds, commodities, and managed futures involve a high degree of risk, often engage in leveraging and other speculative investments practices that may increase risk of investment loss, can be highly illiquid, are not required to provide periodic pricing or valuation information to investors, may involve complex tax structures and delays in distributing important tax information, are subject to the same regulatory requirements as mutual funds, often charge higher fees which may offset any trading profits, and in many cases the underlying investments are not transparent and are known only to the investment manager. The performance of alternative investments can be volatile. There is often no secondary market for an investor’s interest in alternative investments and none is expected to develop. There may be restrictions on transferring interests in any alternative investment. Alternative investment products often execute a substantial portion of their trades on non-US exchanges. Investing in foreign markets may entail risks that differ from those associated with investments in the US markets. Additionally, alternative investments often entail commodity trading which can involve substantial risk of loss.
