How do you insulate yourself from inflation?

The global bond selloff continued this week as investors speculated that the Fed will raise interest rates in December because of signs of inflation. However, if you ask the Social Security Administration, they see no inflation on the horizon. The cost of living adjustment (COLA) for 2017 benefits will only rise 0.3% due to the relatively low inflation rate. They obviously did not consider the 8% rise in health care costs, nor the over 40% rise in oil prices. But, I have noticed that the price of eggs is near 10-year lows.

My first suggestion to insulate from inflation is to eat lots of eggs. Overall, most food prices at the grocery store are lower, which is prompting consumers to cook more and sped less money eating out. Now if you don’t want to eat eggs, or rely on a bump in Social Security, or even eat at home, you can always select investments that benefit from a rise in inflation.

The general advice is to select the right mix of stocks and bonds. There has been no better inflation hedge than the stock market. Real estate has also kept pace with inflation over time. My clients that specialize in real estate are already talking about rising rents next year. On the other hand, REITs (Real Estate Investment Trusts) do very poorly when rates rise. The Vanguard REIT Index is down -9.12% over the last month.

The long-term rise of rates can also cause other “safe” investments to become losing propositions. I’ve written often how traditional low-risk investments have become the riskiest part of investors’ portfolios. For instance, the Vanguard Long-Term Government Bond Index is off -5.22% in the past month.

The new expectation is that there will be less central bank help next year and potentially more infrastructure spending from the government. This shift in policy has caused large investment losses in traditional low-volatility sectors. Investing in companies with pricing power is the best bet. These companies are able to raise prices with changing demand for their products. Even though I don’t own them, tobacco, commodity, alcohol, and firearm companies have historically had the most pricing power.

The sector that has performed the best over the past month are the Financials. Higher interest rates will help to increase their net interest margins. They can generally pass any rising funding cost on to consumers. Other less conventional investments include bank loans and high-yield debt. Bank loans will rise in price as LIBOR increases and High-yield bonds have more credit risk than interest rate risk.

Under these tough economic conditions there are no guarantees to hedging inflation. Diversification is the best advice to hedge inflation. So if you don’t want to stomach eating too many eggs, it will be best to spread the hedge risks across a variety of investments, and not put all your eggs in one basket.

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Advisory services offered through Constant Guidance Financial LLC, a registered investment

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