When you’re looking for the best funds to beat inflation, you’re also looking for funds that can perform well in an environment of rising interest rates and a strong (but eventually weakening) U.S. dollar, which typically coincides with rising inflation.
Inflation — the general rise in the cost of goods and services over time — is a persistent economic phenomenon, which is to say that it’s almost always present and is ongoing. But when inflation begins to really heat up, or more specifically near or above a 3% annual rate, active investors look for various investment types that can outperform in this environment.
Although there are certain investment types that have historically done well when inflation is heating up, there are no guarantees that traditional inflation hedges will work every time. Therefore, it’s important to consider several possible investing strategies that can help you profit in inflationary environments.
With that backdrop in mind, we put together seven of the best funds to buy in diverse categories to profit from inflation.
Best Funds to Beat Inflation: iShares Core S&P 500 Index (IVV)
Expense Ratio: 0.04%, or $4 annually per $10,000 invested
The best overall asset type that can beat inflation is stocks and a smart way to get broad exposure to the stock market is with a cheap exchange-traded fund like iShares Core S&P 500 (NYSEARCA:IVV).
The three basic types of investment assets are stocks, bonds and cash. Out of those three, stocks are your best bet to beat inflation. For this reason, we start our list of the best funds to beat inflation with the classic strategy of using a low-cost fund that passively invests in a diversified mix of U.S. stocks.
IVV tracks the S&P 500 index, which is a cap-weighted index that includes about 500 of the largest U.S. companies like top holdings Apple (NASDAQ:AAPL), Microsoft (NASDAQ:MSFT) and Amazon (NASDAQ:AMZN).
Best Funds to Beat Inflation: Fidelity Real Estate Investment Portfolio (FRESX)
Expense Ratio: 0.76%
The real estate sector has historically benefited from inflation and the Fidelity Real Estate Investment Portfolio (MUTF:FRESX) is a smart choice to take advantage of this trend.
Real estate can benefit from inflation in two primary ways: 1) Property values are increasing and 2) Rents are rising. This double combination of growth and income makes REIT funds attractive in inflationary environments.
While passively managed index funds and ETFs can be a good way to capture the REIT market, an actively managed fund with a strong performance record like FRESX can be better than the index route.
Lead manager Steve Buller has been at the helm of FRESX for more than 20 years and has averaged top quartile rankings among other REIT funds during that tenure. Top holdings for FRESX were recently Simon Property Group (NYSE:SPG), Prologis (NYSE:PLD) and Public Storage (NYSE:PSA).
Best Funds to Beat Inflation: SPDR Gold Shares (GLD)
Expense Ratio: 0.40%
Inflation erodes the value of paper currencies, such as the U.S. dollar, and investors have historically turned to gold ETFs like SPDR Gold Shares (NYSEARCA:GLD) as a hedge.
Although gold is traditionally considered a hedge against inflation, the timing for buying the precious metal can be tricky. For example, when inflation is just beginning to heat up, such as a period when the Federal Reserve begins to raise interest rates to keep inflation in check, the U.S. dollar tends to be strong in relation to other currencies. A strong dollar will typically hold down the demand and the price for gold.
However, when inflation begins to take its toll on other assets, such as stocks and bonds, and the Fed has been raising interest rates for an extended period of time, investors tend to flock to gold and ETFs like GLD. This is because higher rates will eventually weaken the U.S. dollar and it is prudent to prepare for the inevitable recession, when gold funds tend to remain positive and stocks are negative.
Best Funds to Beat Inflation: Energy Select Sector SPDR (XLE)
Expense Ratio: 0.13%
Oil prices and inflation tend to move in the same direction, which means ETFs like Energy Select Sector SPDR (NYSEARCA:XLE) can be a smart play when inflation is heating up.
Although the correlation between oil prices and the Consumer Price Index (CPI) has declined since the 1970’s, investment in oil and energy should still be on your top list of investment choices to consider for inflationary periods.
You can’t directly invest in oil but you can buy funds that indirectly invest in this commodity. A good way to tap into oil this way is to invest in a cheap energy sector ETF like XLE, which holds about 30 U.S. energy stocks, such as Exxon (NYSE:XOM), Chevron (NYSE:CVX) and Schlumberger Ltd (NYSE:SLB).
Best Funds to Beat Inflation: Vanguard Inflation-Protected Securities (VIPSX)
Expense Ratio: 0.20%
Bonds prices tend to fall in inflationary environments but a good TIPS fund like Vanguard Inflation-Protected Securities (MUTF:VIPSX) can perform relatively well.
Treasury inflation-protected securities, aka TIPS, are Treasury bonds in which the principal value adjusts up or down based on inflation, as measured by the CPI.
When inflation is rising, the Federal Reserve is often raising interest rates, which places downward pressure on bond prices. However a good, low-cost TIPS fund can hedge against interest rate risk with its inflation-adjusted principal on the underlying bonds. Keep in mind, however, that TIPS funds can still decline in value when rates are rising, although not typically as much as funds that invest in conventional bonds.
Best Funds to Beat Inflation: Vanguard Ultra Short-Term Bond (VUBFX)
Expense Ratio: 0.20%
Another fixed income alternative during inflationary periods is funds that hold short-term bonds. This makes Vanguard Ultra Short-Term Bond (MUTF:VUBFX) a smart choice to buy for inflation.
Bond prices generally move in the opposite direction as interest rates, which are typically rising along with inflation. Also, the longer the duration of the bond, the greater the interest rate sensitivity. Therefore, when interest rates are rising, an ultra short-term bond would generally be affected the least.
For example, through Aug. 20, 2018, when the Fed was actively raising rates, VUBFX had a gain of 1%, whereas the Bloomberg Barclays Aggregate Bond Index was down 0.8%.
Best Funds to Beat Inflation: Fidelity Contrafund (FCNTX)
Expense Ratio: 0.74%
Inflationary periods generally coincide with the mature phase of the business cycle, which is also a good environment for outstanding growth stock funds like Fidelity Contrafund (MUTF:FCNTX).
Stocks are traditionally the go-to investment for beating inflation in the long run, but you can potentially get the biggest gains with well-managed growth stock funds when the economy is strong and inflation gets the hottest.
FCNTX has a track record of beating the S&P 500, largely due to long-time manager, William Danoff, who has been at the helm of the fund for 28 years. Danoff does a great job of buying growth stocks like Facebook (NASDAQ:FB) and Amazon (NASDAQ:AMZN) but it may also add value stocks like Berkshire Hathaway (NYSE:BRK.A, NYSE:BRK.B).
As of this writing, Kent Thune did not personally hold a position in any of the aforementioned securities, although he holds IVV, XLE, GLD, VIPSX, and FCNTX in some client accounts. Under no circumstances does this information represent a recommendation to buy or sell securities.