By Jacqueline Alemany, CNN • Updated 20th August 2016
A small increase in the price of an airline ticket might not seem like a big deal. But inflation eating away at your investment dollars will be a bigger challenge for many people.
Jeffrey Freedman, executive vice president of Calvert Investments, said the biggest risk to investors these days is inflation. “Investors would be crazy to leave their investment funds in cash,” he said.
With the Federal Reserve setting interest rates that haven’t been in the market in decades, inflation has returned to the discussion among Wall Street investors. On Tuesday, the central bank released an annual report on the economy, noting that inflation has increased in the last six months, partly due to rising energy prices.
It’s good news for people who own Treasuries, which offer a return when interest rates drop, though big investors are warning that rising inflation means that interest rates need to rise to combat inflation. That means higher mortgage rates, and even higher rates on credit cards, which would make it more expensive to go on vacation or buy a new car.
If you invest in bonds and cash, you’re protected from inflation, said Freedman. But you can’t expect to automatically protect your retirement savings from inflation.
“The strategy is not just to move money to fixed-income securities, but also to add stocks,” he said. “That takes a little bit of time, because you have to realize that inflation will rise.”
Three ways to be prepared
Many people use inflation as a measure of how overvalued investments are at any given time. The problem is that the way people choose investments can lock them into a time horizon that’s just a few years. So, if the market continues to increase in price over the next few years, your investments will likely continue to increase in value.
Instead, he says, investors should aim to invest in things that only increase with inflation.
A basket of companies with a long history of increasing their dividend payments can perform well if inflation continues, Freedman said. “Over the last century, in the periods with low inflation or no inflation, that group of companies tends to perform better than the market as a whole.”
Investors should stick to companies that are profitable in the long term, he said. That means companies that can pay you back for investing in their business that should grow in value over time.
“A company that has a diversified business model, can price its products fairly well (and) has a reputation for innovation is a company that has the ability to increase its dividend,” Freedman said.
Freedman recommends two ETFs: the Vanguard Utilities ETF and the WisdomTree Dividend ex-Financials. The Vanguard ETF should hold companies that cover the entire market in utilities and utilities-related stocks. It also holds telecom and consumer stocks. The WisdomTree ETF should hold companies that are primarily in financial companies but not in the insurance industry, he said.
“These ETFs will hold diversified portfolios, and will outperform their benchmarks,” Freedman said.