Welcome to another installment of project “passive wealth,” where I will be releasing my next book on investing (working title: “The Rational Investor”) chapter by chapter to paid subscribers of Making of a Millionaire.
You can catch up on previous chapters of the book here.
Chapter 29: Does Inflation Hedging Work?
So far, we have discussed some of the scariest investment narratives that the financial media, opportunistic investment advisors, and online influencers will use to scare the rational investor into deviating from a passive buy-and-hold index strategy.
These narratives include economic recessions, rising interest rates, and even war.
But there is only one narrative to rule them all, and that narrative is inflation. There is no narrative that is used so blatantly to capitalize on the fear of investors and everyday consumers as inflation.
Whether you have money invested or not, we all feel the impacts when inflation is high. If inflation is higher than wage growth, quality of life drops.
When we experience higher than normal inflation, you’ll read countless headlines like “The death of the dollar,” “It’s time to buy gold,” or “Inflation is destroying your wealth.”
So, how does the rational investor deal with periods of high inflation?
They do absolutely nothing.
Hedging for inflation is no easy task
One subnarrative you will likely hear during times of high inflation is the different inflation hedges you should invest in to protect your money from inflation.
Without addressing any of the individual investments that are often marketed as inflation hedges, there is a fundamental truth that you need to know. By the time high inflation has arrived, you have likely missed your opportunity to hedge against it.
The closest thing to a true inflation hedge is likely Treasury inflation-protected securities (TIPS) issued by the U.S. government (or an equivalent real return bond in other countries.) The principal of these bonds rises alongside inflation.
However, if you purchase TIPS after inflation has already spiked, then you lose the hedging benefit unless inflation continues to increase for a prolonged period.
TIPS are only an effective inflation hedge if you hold them in your portfolio before inflation spikes. This comes at a cost as TIPS generally have lower expected returns during periods of moderate to low inflation. This creates a drag on portfolio returns.