Investing to Beat Inflation

Investing to beat inflation means putting money to work in assets that have the potential to generate returns above the rate of rising prices. Of course, no asset class guarantees this outcome and, as with all investments, they all carry meaningful risk. However, historically, certain investments have proven more resilient during inflationary periods than others. 

This article explores how inflation affects savings and investments, which asset classes tend to offer some degree of protection and what characteristics to look for when looking for inflation-resistant stocks.

The information in this article is provided for educational purposes only and does not constitute financial advice. Consult a financial advisor before making investment decisions.

What Is Inflation and Why Does It Matter for Investors?

Inflation is the rate at which the general price of goods and services rises over time. As prices increase, a currency’s purchasing power decreases, as each unit of currency buys less than it did before. 

Inflation is typically measured using the Consumer Price Index (CPI), which tracks the change in prices of a basket of everyday goods and services. When CPI rises, inflation is increasing. 

A low, stable rate of inflation is generally considered healthy for an economy, with many central banks actively targeting an annual rate of around 2%. When inflation climbs significantly above this target, as it did across much of the world between 2021 and 2023, the effects on household finances can be considerable. 

For investors, this matters because any investment that generates a return below the rate of inflation is effectively losing value in real terms, even if it appears to grow in nominal terms. For example, a savings account paying 2% interest whilst inflation is 5% is effectively losing 3% in real terms. 

Real Return ≈ Nominal Return − Inflation Rate

Investing to Beat Inflation: Asset Classes to Consider

When thinking about how to invest during inflation, it helps to draw a distinction between two objectives: 

• Hedging Against Inflation: Aims to protect purchasing power over the short-to-medium term by using defensive assets. 
• Investing to Beat Inflation: Attempts to generate returns that outpace the rate of inflation, increasing real wealth over the long-term. 

In the following sections, we’ll take a look at different asset classes and examine how they are typically affected by inflation. 

Cash

Perhaps unsurprisingly, cash is the asset class most vulnerable to inflation. If the interest rate on your savings account falls below the rate of inflation, the real value of the money held in that account declines over time. 

During periods of elevated inflation, the gap between rates on savings accounts and the pace at which prices are increasing can become substantial. Even when central banks hike interest rates to combat rising prices, rate changes can take time to filter through to savers. 

Cash has a role in a portfolio as an emergency fund and a short-term store of liquidity. However, in terms of preserving or growing wealth, it has significant limitations, particularly during inflationary periods. 

Equities

Over the long term, stocks have historically been one of the more effective ways of generating returns that outpace inflation. However, this is far from guaranteed, with performance varying considerably depending on wider circumstances. 

Whilst the short-term effect of inflation can be bad for businesses, over time, they can potentially adapt to rising costs and grow revenue and earnings in nominal terms. As earnings rise, this tends to be reflected in share prices. 

However, some stocks can weather an inflationary period better than others. Companies which have a high degree of pricing power, the ability to raise prices without significantly losing demand, tend to hold up better than those which don’t. Such companies are able to pass rising costs onto consumers, keeping profit margins intact. 

Gold and Commodities

Gold has long been regarded as an inflation hedge, an asset that tends to retain or increase in value as the purchasing power of currencies decline.  

Human beings have viewed gold as a store of value for centuries, and its reputation as an inflation hedge is reinforced by its limited supply; the precious metal cannot be printed in the same way a paper currency can. 

Commodities in general - including oil, natural gas and metals - also tend to rise in price during inflationary periods. This is because they themselves are often a driver of inflation in the first place. As the building blocks of other goods and services, rising commodity prices push up costs across the economy. Consequently, exposure to commodities is often viewed as a hedge against inflation. 

Property

Property has traditionally been considered to provide a degree of protection from inflation, as both property prices and rental income tend to rise alongside the general price level. However, directly investing in property is capital-intensive and the asset itself is very illiquid (i.e. it is not quick or easy to convert into cash). 

Real Estate Investment Trusts, REITs, offer investors a more accessible route. REITs are companies that own and operate income-producing real estate, and their shares can be bought and sold like any other stock. Because rental income tends to adjust upwards over time, certain REITs can offer a degree of inflation protection whilst also providing dividend income.  

However, two things are important to note: 

• Not all REITs are equal. REITs with portfolios focused on residential property, healthcare facilities and supermarkets benefit from more inelastic demand. This means their rental income is less sensitive to economic conditions, which can make them more resistant to inflation. 
• REITs are sensitive to interest rates. During inflationary periods, central banks typically hike rates to combat rising prices. Many REITs have high levels of debt; as interest rates rise, the cost of servicing this debt increases, which can weigh on share prices.  

Bonds

Conventional bonds tend to struggle during inflationary periods, as rising prices erode the real value of their fixed interest payments and the principal which they return at maturity. Furthermore, their prices have an inverse relationship with interest rates, meaning that if interest rates increase, bond prices tend to fall. 

Inflation-linked bonds address this issue by structuring returns to adjust in line with inflation. This offers bondholders a degree of protection that standard fixed-income instruments do not. However, it’s worth noting that they represent a relatively small segment of the total global bond market. 

Diversification

In practice, many investors do not rely on a single asset class to achieve their goals, during inflationary periods or otherwise. 

Diversifying exposure across a range of assets is a widely used approach for building a long-term portfolio. No single asset class performs well in all economic environments, and diversification can help offset the negative impact of any single holding. 

For example, an investor seeking to beat inflation over the long term might hold a core allocation to equities, complemented by exposure to commodities or REITs as a hedge against shorter-term inflation.

Stocks That Tend to Do Well During Inflation

Whilst equities as a whole have historically tended to outpace inflation over the long-term, some stocks are better placed than others to weather inflationary pressure. 

Here are three key characteristics to bear in mind when looking for such stocks: 

• Pricing Power: The ability to raise prices without significantly affecting demand. 
• Inelastic Demand: Goods and services that consumers continue to buy regardless of changes in price or income. 
• Reliable Income: A steady, predictable revenue stream that holds up across different economic conditions. 

Below, we look at two stocks that have historically demonstrated these characteristics. 

Coca-Cola

Coca-Cola is one of the world’s most recognisable brands, selling a wide variety of beverages which many people buy habitually. 

The high level of brand loyalty it enjoys affords the company a significant degree of pricing power. When input costs rise, Coca-Cola has historically been able to pass these increases on to consumers without experiencing a significant drop in demand. 

The beverage giant’s revenue is also diversified across more than 200 countries, meaning that its business is not overly reliant on any single market. Its global reach, brand loyalty and strong pricing power make Coca-Cola a key example of a stock which is well-placed to hold up well during periods of elevated inflation. 

Nevertheless, it’s worth noting that its business is not immune to cost pressures; rising prices for key ingredients such as sugar can affect its margins. Although its pricing power has historically been sufficient to offset these pressures, it may not be indefinitely.  

Mastercard

Global payment processor Mastercard operates alongside Visa in what is effectively a duopoly on card payment processing worldwide. 

Every time a transaction is processed through its payment network, Mastercard collects what’s known as an “assessment fee”, which is calculated as a percentage of the transaction value. 

This business model naturally provides Mastercard with protection from inflation. As prices rise, the value of transactions being processed through Mastercard’s network also rises, and so do its fees. Consequently, unlike other companies, Mastercard doesn’t need to worry about raising prices to offset inflation, its percentage-based fee structure means that revenue rises automatically. 

However, it’s worth noting that a prolonged period of high inflation could lead to reduced consumer spending, which would weigh on Mastercard’s payment network revenue. 

How to Invest During Inflation

The asset classes discussed in this article can be accessed in a variety of ways, depending on the asset in question and your preferred approach. 

• Equities: Individual stocks can be purchased through a broker. Investors may also consider Exchange-Traded Funds (ETFs) focused on inflation resilient sectors, such as consumer staples. 
• Gold and Commodities: For retail investors, commodity exposure is most commonly gained through ETFs or Exchange-Traded Commodities (ETCs), or indirectly by investing in energy or mining stocks. 
• REITs: REITs trade on stock exchanges in the same way as regular shares. 
• Inflation-Linked Bonds: For retail investors, inflation-linked bonds are perhaps most practically accessed through ETFs which focus on these types of bonds. 

Before investing, there are a few practical considerations worth thinking through: 

• What real return do you need? Comparing an asset’s expected returns against the current inflation rate can help clarify whether it is likely to preserve or increase your purchasing power. 
• How much liquidity do you need? Keeping sufficient cash for short-term needs and emergencies is sensible. 
• What is your time horizon? Assets with the strongest historical case for beating inflation generally require a long-term view. 
• How much risk are you comfortable with? Different asset classes carry different risk profiles. 
• Are fees and costs accounted for? Investment costs also reduce real returns, so it’s important to factor those into your decision-making. 

Investing to Beat Inflation: Key Takeaways

• Inflation erodes the purchasing power of money over time. Any investment generating a return below the rate of inflation loses value in real terms, even if its nominal value rises. 
• Cash is the asset class most vulnerable to inflation. Savings account interest rates have historically struggled to keep pace with inflation during elevated periods, which results in negative real returns. 
• Investing to beat inflation over the long term has historically meant investing in equities. Whilst future performance is never guaranteed, historically, stocks have tended to outpace inflation over extended time horizons. 
• Companies with strong pricing power, inelastic demand and reliable income streams tend to be more resilient when it comes to weathering inflationary pressure. 
• Other asset classes - such as commodities, REITs and inflation-linked bonds - can also play a role, although primarily as shorter-term hedges against inflation. 

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