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The Shearwater Report, July 2021 Inflation: Hedging Your Bets

By Jeffrey J. Brown, MD, MBA, CFA®, CFP®

Investors have been increasingly concerned about inflation recently, and with good cause. In May, the Bureau of Labor Statistics reported a 4.2% rise in U.S. consumer prices from a year earlier. Although the Federal Reserve has been downplaying the significance of this report, the current inflation worries seem warranted. We have several tools in our investment armamentarium to hedge against inflation. While no single strategy is 100% effective, a combined approach can help mitigate the damaging effects of inflation over time.

Investing in stocks is the most common way to fight inflation. As illustrated below, the U.S. stock market has beaten inflation handily since 1926, while U.S. Treasury bills have failed to keep pace.

Growth of $1 from 1926 to May 2021

(Source: Dimensional Fund Advisors)

Although stocks have historically outperformed inflation, there have been periods when inflation-adjusted stock returns have been less than stellar. For example, during the 17-year period from 1966 to 1982, the inflation adjusted S&P 500 return was essentially 0%. It is therefore helpful to incorporate some additional strategies to hedge against inflation.

What about gold? The most convenient way to invest in gold is with an exchange-traded fund (ETF) that closely tracks the price of gold, such as SPDR Gold Shares (GLD) or Aberdeen Standard Physical Gold Shares (SGOL). While gold has served as an inflation hedge for millennia, its price can fluctuate significantly prompting some investors to diversify into other precious metals such as silver and platinum. Further diversification can be achieved by investing in a broad basket of commodities, such as the DFA Commodity Strategy Portfolio (DCMSX).

Investing in inflation-protected bonds is another strategy to hedge against inflation.

Dimensional Fund Advisors

(DFA) offers a suite of inflation-protected bond strategies. These strategies include Treasury Inflation Protected Securities (TIPS) funds that are well-suited for tax-deferred accounts and municipal bond real return funds that are appropriate for taxable accounts.

Finally, real estate can provide a hedge against inflation in some situations. Many investors have real estate equity in their own home, which can be supplemented with diversified real estate funds. Real estate investment trusts (REITs) are required to distribute 90% of their taxable income to shareholders each year as dividends and therefore should only be held in tax-advantaged accounts.

Since most investors are saving to support future spending, outpacing inflation is important. Using several strategies in combination helps to position your portfolio to withstand the rigors of inflation over time.

About Jeff

Jeffrey Brown is principal and chief investment officer at Shearwater Capital, LLC, a fee-only fiduciary financial advisory firm helping physicians and their families attain financial security using a scientific, evidence-based approach. Jeff has been a practicing radiologist for over 30 years and is currently chair of the Department of Radiology at Saint Louis University School of Medicine. He earned his bachelor’s degree from the University of California, Irvine and his medical degree from the University of California, San Diego. He has been named one of St. Louis’s Top Doctors every year since 2011 in St. Louis Magazine. Jeff saw a need for physician-tailored financial services and earned an MBA from Washington University in St. Louis, going on to found Shearwater Capital, LLC with fellow MBA classmate and radiologist, Eric Malden. Jeff is a Chartered Financial Analyst (CFA®) and CERTIFIED FINANCIAL PLANNER® (CFP®) practitioner. Learn more about Jeff by connecting with him on LinkedIn.

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