Investing in a time of inflation

Recent upheaval in the equity and bond markets has investors understandably nervous. Many readers have written saying their portfolios have fallen in value, and they wonder what actions they can take, given that inflation is likely to persist at high levels and markets will remain volatile.

Many readers have indicated they have already sold some of their equity and are keeping some assets in money market funds, and they want to know what other options will protect their asset base.

I have written in previous columns that one option is investing in Series I bonds. You can go to TreasuryDirect.gov and read about all of the features. As an individual, you can only purchase $10,000 each year; if you are married, you can invest a total of $20,000 per year. You can also add an additional $5,000 a year if you expect a tax refund.

If you purchase an I bond before April, you will obtain a return of 7.12% for the first six months you own the bond. In April, the Federal Reserve will set a new rate based on the consumer price index at that time. You can be pretty sure that the new rate will also be high, perhaps even greater than 7.12%. Any increase in value will be deferred until you redeem the bond. You will be taxed on the gain at the federal level, but there is no tax at the state or local level. The maturity is 30 years, but you can redeem it after one year. If you redeem it before you have held it for five years, you lose the last 3 months of interest.

Another option is Treasury Inflation-Protected Securities (TIPS). Unlike I bonds, there is effectively no limit regarding how much you can invest in them (you can buy up to $5 million in TIPS at any single auction using TreasuryDirect). The interest paid on TIPS is also based on the consumer price index, but they do have a disadvantage in comparison to I bonds. For example, the yield on 5-year TIPS is now minus 1.2%; for I bonds, the fixed rate is now 0% and the rate is never less than zero. The bottom line is that you will receive a 120-point advantage now purchasing I bonds vs. TIPS. The interest paid on both is based on the consumer price index, and changes every six months.

You can buy TIPS directly from TreasuryDirect or from a financial institution in the form of a mutual fund or exchangetraded fund. If you buy them through a mutual fund/ETF, you will receive the interest paid each six months, and interest is taxable. If you buy the bonds from TreasuryDirect, the interest will be credited to your account, but it is taxable in the year paid.

One of the disadvantages of buying TIPS via mutual funds or ETFs is that the value of the investment fluctuates based on interest rates, in general, and you could incur an investment loss if you are a shortterm investor. For example, if you held shares in a TIPS fund/ETF last year, you would have received a return of approximately 6%. In 2022, however, you would likely be facing a loss in value. I suggest that you purchase TIPS from the Treasury directly and invest on a longer-term basis.

Another strategy you can consider is a modest investment, such as 1% of your portfolio in commodities. In general, commodity prices, assuming a balanced group of commodities, increase in value when inflation rates are high. In 2022, mutual funds and ETFs that invest in multiple commodities have done very well. However, the values of these funds are volatile. These funds can fluctuate as much as 5% up or down in one day. Accordingly, I would not recommend investing a high percentage of your portfolio in commodities. But when equity prices have a significant fall in value, commodity investments generally do well. You can ask your financial adviser for a specific recommendation.

A final note on I bond investment limits: I recommend that you write, as I did, to Treasury Secretary Janet Yellen and to President Joe Biden, requesting that steps be taken to increase the yearly limit for the purchase of I bonds from $10,000 per year individual to a higher amount, such as $50,000 per year. The relevant addresses are janet.yellen@frb.gov and president@ whitehouse.gov.

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