Published - December 2, 2022 @ 1:00 PM (EET)
By now, consumers around the world are all too familiar with inflation, the term used to describe the steady rise of prices for goods and services that affect all areas of the economy.
As companies continue their battle with supply chain disruption more than two years into the pandemic, it has become clear that a dollar today will not buy the same value of goods we bought in a grocery store pre-COVID.
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One way to avoid this is to hedge against inflation.
HEDGING EXPLAINED
Used in the financial markets by traders and investors, hedging is a method that mitigates risk by opening an opposing position in the market to offset any loss incurred on the main position.
However, reducing the risk through hedging also typically results in a reduced potential for profits. Various instruments must therefore be employed strategically in the investment world to hedge effectively.
Here are some ways to hedge against inflation:
COMMODITIES
Traditionally, gold has been a safe-haven asset when inflation increases or interest rates are low. The one way to invest in gold or any other commodities is to buy it through ETFs.
Unlike soft commodities like wheat or cattle and energy products like crude oil and natural gas, investors also have the option to buy and hold physical gold or the stock of gold miners.
One exchange-traded fund worth investing in is the iShares S&P GSCI Commodity-Indexed Trust. However, investors should note the volatility of commodity investing as it largely depends on demand and supply factors.
TIPS
Treasury inflation-protected securities are a type of US government bond that is indexed and mirrors the rise and fall of inflation to protect investors.
This means that when inflation climbs, so does the interest rate paid, and when deflation occurs, interest rates drop.
Since TIPS are backed by the US federal government and move in line with the Consumer Price Index (CPI), they are one of the safest types of investments and an easy way for investors to diversify their portfolios.
DERIVATIVES / INFLATION SWAP
Known as a derivative contract, an inflation swap occurs between two counterparties to transfer inflation risk by exchanging fixed cash flows.
Unlike other derivatives traded on an exchange, inflation swaps can only take place over-the-counter and are used specifically to transfer inflation risk from one party to another.
Inflation swaps can be a useful tool for investors to lock in prices and hedge against unfavorable movements in rates and make derivatives even less expensive, investors can also often purchase them on margin, meaning traders use borrowed funds to buy them.
CRYPTO
It remains to be seen whether cryptocurrencies will serve as a reliable inflation hedge over the long term.
Yet, despite Bitcoin's failure to counter this year's rampant global inflation, Amy Arnott, a portfolio strategist at Morningstar, says, "Bitcoin should theoretically protect against inflation because of limited supply."
Elsewhere, the managing director of private consumers at Swan Bitcoin, Steven Lubka, believes cryptocurrencies are a good hedge against inflation since it doesn't require maintenance and poses less risk than other strategies against price fluctuations.
STOCKS
Even if stocks may get hit by anxious investors in the short term, having a well-constructed portfolio of securities is a great long-term vehicle for hedging against inflation.
Historically, while the stock market may experience a downturn, it has still delivered returns that have beat inflation, with the average stock market returns clocking 12.3% per year over the past 95 years.
While you can invest through a retirement account or an individual retirement account, you can also open a brokerage account, giving you access to investment apps that can help you choose your investments.
