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Which Investments Perform Best Against Inflation?





Inflation is one of the few problems the economy hasn't encountered in recent years, but it could be making a comeback. This makes it worth a look at what you might expect from some major investment classes if inflation does perk up.

Inflation: a recent and longer-term history

In the past 20 years, there has been only one calendar year in which inflation exceeded 4 percent. But in the 20 years before that, it was a completely different story. Inflation was above 4 percent for 13 of those years, with a high of 13.3 percent in 1979.

What could trigger a return of inflation? The price of oil is always a prime suspect. It was a driving force behind June's inflation rising to 0.5 percent (which would project to an annual rate of more than 6 percent), and oil prices continued to surge in the first weeks of July.

With the possibility of a return to higher inflation, investors may want to familiarize themselves with the history of how different asset classes have performed under inflationary conditions.

Searching for safe havens

Below is a look at how some asset classes have performed over the past 40 years when inflation has been above 4 percent for the calendar year. This has happened 14 times, for a compound average annual inflation rate of 7.58 percent during those years. Since history does not usually repeat itself in a precise and orderly manner, this history is accompanied by some cautions on why things might be different going forward:

  1. Gold. Gold has a reputation as an inflation hedge, and indeed, of the asset classes discussed here, it has the best historical returns in high-inflation years with an annualized average of 16.18 percent. However, it isn't the most reliable inflation hedge. Overall, in 14 years when inflation exceeded 4 percent, the price of gold beat the inflation rate in 8 of them, but had a negative return in 6. Also, the first decade of this century saw a steep rise in the price of gold in a non-inflationary environment, which makes it debatable how much near-term potential gold prices have left in them.
  2. Deposit accounts. Sometimes slow and steady is the way to go. According to Federal Reserve data, one-month CD rates beat the Consumer Price Index (CPI) in nine of the 14 high-inflation years, and beat inflation overall with a compound average annual return of 8.59 percent during those 14 years. One caution though: Those CD rates are close to zero today, so they have some catching up to do to get past inflation.
  3. Bonds. Bonds were the worst performers of this group in high inflation years, with an annualized return of just 4.45 percent. They beat inflation in just 6 of the 14 high-inflation years.
  4. Stocks. Despite beating the CPI in eight of the 14 high-inflation years, stocks trailed inflation overall during those years with an annualized return of 7.04 percent. Stocks have been a major beneficiary of low interest rates in recent years, so they may struggle if inflation pushes those rates higher.

The bottom line is that it is difficult for investors to find a clear win when inflation strikes. The best strategy may simply be to minimize the damage, and hang on until inflation eases.

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