Analyzing the Market
The market has had a poor start to the year. As of May 11, 2022, the S&P 500 was down 17%. That being said, local financial advisors are urging clients to stay invested because jumping ship in a downturn can be detrimental to your portfolio.
If you take return data from the S&P 500 for the past 20 years, you will find that missing only the best 10 days would take your return from 9.52% to 5.33%. This means that a $10,000 investment would go from $61,685 (had you stayed on the ship) to a measly $28,260. You could lose $33,425 over a 20-year period if you missed only the 10 best days.
And here’s the real kicker: seven of the best 10 days in this 20-year period were within just two weeks of the 10 worst days. That’s why financial advisors do all they can to keep their clients from pulling out of their investments during market downturns.
But, despite financial professionals’ pleas, investors often move towards so-called inflation hedges. In recent years inflation hedges have included commodities such as gold, real estate, cryptocurrencies, US treasuries, and many more. The question is, do these “safe havens” actually hedge against inflation?
Gold and Other Commodities
Gold has long been considered an inflation hedge. This is because gold often increases in value when inflation is on the rise. Although this is generally true, investors need to consider the downfalls of investing in gold.
Volatility plagues gold and other commodities. The Bloomberg commodity index has commodities up 28.7% so far this year. But, looking back, the index was down from 2011 to 2022 for an average return of -2.6%. This includes years like 2021 (up 27%), 2009 (up 19%), and 2007 (up 16%). Another problem that often occurs is investors usually buy gold when it’s already at its peak. Buying gold when you already feel inflation defeats the whole purpose of inflation hedging.
In an ideal world, you would have bought gold before inflationary pressures to avoid buying high and selling low. This is called timing the market, however. The data overwhelmingly proves that when investors try to time the market, they lose. The only other option is to take a long-term approach to gold and commodity investing, but as we see, commodities lose value over time.
In recent news, bitcoin has taken a huge hit since its peak in November. Record high inflation occurring simultaneously with the deep dive of cryptocurrency should be evidence alone that cryptocurrency is not an inflation hedge. Crypto investors are beginning to understand the volatility associated with the new form of currency. It’s because of the volatility and clouded understanding of cryptocurrency’s correlation and value that the SEC has not jumped on the bandwagon.
A chart of the value of bitcoin shows a small pattern of reliable growth. Interestingly, bitcoin does share a pattern with the dotcom and other bubbles we have experienced. Although no one can be certain of the future, investors should understand that investing in cryptocurrency shouldn’t be considered investing at all but rather speculation. The short life of cryptocurrency has yet to prove to be a reliable inflation hedge.
Treasury inflation-protected securities (TIPS) are a way for investors to lessen their exposure to inflation risk. TIPS are adjusted for inflation semi-annually. Rather than changing the interest rate, the par value is adjusted for inflation. One downfall to TIPS is that they aren’t very tax efficient. Increases to par value are considered taxable income even though the increase didn’t necessarily make it into your pocket. For this reason, many investors hold U.S. Treasuries in mutual funds or tax-deferred accounts.
Series-I savings bonds are another tool to combat inflation. By October of 2022, savings bonds are yielding 9.62%. Series-I savings bonds are low-risk investments, and during high inflationary periods, they are attractive places to stick cash because they have attractive yields. There are some limitations. An investor is limited to $10,000, and you can’t cash out for at least a year. If you cash out before 5 years, you must give up the previous 3 months of interest.
In today’s high inflation environment, there are few options to hedge inflation. The year-to-date inflation rate is around 8.3%. The unprecedented spike in inflation has given investors few options to seek asylum. Although there is little investors can do in the short term, a well-strategized financial plan can help prepare them to hedge against inflation in the long term. Historical data shows that stocks are often the best form of inflation hedge available to investors. Dating back to 1926, the S&P 500 has returned 10.5%, and inflation, dating back to 1926, has been around 3%.
Stay on the Ship
John Ray said, “He that cannot abide a bad market, deserves not a good one.” Although looking at your 401(k) statement or the receipt at the gas pump may send you into utter shock, remember the long-term goal and the bigger picture. Investing in your future is like walking up a staircase with a yo-yo. There will be times when you are down big, but remembering that you are still walking up the staircase can be the difference between running out of money and accomplishing all of your goals. That being said, your best inflation hedge is simply staying invested, staying on the ship.
Whether you need help managing your wealth or are soon retiring in Boise, Idaho, you need a trusted financial advisor by your side. The team at TrueNorth Wealth is here to help! We offer fee-only financial services, so you know we only have your best interests in mind. Call us today to schedule a no-cost consultation.