By Dr. Jim Dahle, WCI Founder

2021 and 2022 were the first years in decades in which US investors faced significant inflation.

While inflation was in double digits for three years around 1980, it had not been over 5% since 1990 (or even over 3% since 2011). Then, wham! It was 4.7% in 2021 and over 7% in 2022, with year-over-year inflation peaking at more than 9% and monthly inflation peaking at 1.37% in June 2022. For years, investors have been talking about hedging against inflation, only to find out that most of these “inflation hedges” didn't really work when the rubber hit the road.

That is to say, those supposed hedges didn't go way up in value to help offset the rest of the portfolio when inflation did increase. Check out this list of asset class returns for 2022:

  • Long-term bonds: -27.22%
  • Short-term bonds: -5.54%
  • US Stock Market: -19.53%
  • International Stock Market: -16.01%
  • Publicly Traded REITs: -26.20%
  • Commodities ETF: 24.08%
  • Oil ETF: 28.97%
  • Gold ETF: -0.77%
  • Silver ETF: 2.37%
  • Bitcoin: -65%
  • Long-term TIPS: -31.68%
  • Short-term TIPS: -2.96%
  • I Bonds: 5.45%
  • G Fund: 2.98%
  • Cash: 1.55%

See what I mean? Almost nothing “worked,” if we define “working” as having great returns in a year with bad inflation—or at least returns higher than inflation. Only two asset classes outperformed inflation. Oil and a broad commodities ETF (which is mostly oil) had great returns. However, it would take an investor with an iron stomach to have held that investment from 2007-2022 when it finally “worked.” The annualized returns for the Oil ETF were -13.39% per year for those 15 years, and even for the broader commodities ETF, they were -5.89% per year. Minus-13.39% is an absolutely horrendous performance. That means if you started with $100,000, you ended with $11,000 after 15 years. And that 15-year period includes 2022! It was even worse before.

Bonds and stocks certainly didn't work. Real estate had even worse returns. Gold, silver, and Bitcoin? Nope. Not even close. TIPS are supposed to hedge inflation, right? No, they were down about as much as other bonds. Cash and “cash on steroids” (the federal TSP G Fund) underperformed inflation by 4%-6%.

Only I bonds seemed to have a decent year, benefitting from the fact that they don't go down in value and yet still have their yield adjusted upward with inflation. How did my I bond investment do in 2022? I only made 5.45%, still less than inflation for the year. Now, it is true that the yield peaked at 9.62%, but I bought $20,000 of I bonds in December 2021, $20,000 in January 2022, and $10,000 in April 2022, and my overall return was only 5.45% for the year. To be fair, some of that return due to the high inflation in 2022 will come to me in 2023, but even so, I bonds have another issue—you can only buy so many of them in any given year.

You can hedge a $100,000 portfolio with them but not a $1 million portfolio, much less a $10 million portfolio.


The Good News

There is a silver lining to all this, of course. You don't actually need to hedge inflation in the short term. You need a portfolio that keeps up with inflation in the long term. Inflation has an erosive effect on your purchasing power, but even 7%-10% inflation in one year doesn't kill your portfolio. It's prolonged inflation that does so. And the good news is that there are many investments out there that can keep up with or beat inflation in the long run. You don't need to “hedge;” you just need to make sure your portfolio is growing faster than inflation in the long run.

TIPS, particularly when purchased individually, are exceptionally good at keeping up/beating inflation but only when held to maturity. If you buy a 1.5% 30-year TIPS, you, in 30 years, will have made 1.5% per year in real terms. They are very risky/volatile investments in the short term but riskless in the long run.

hedge against inflation

I bonds can make up a smaller portion of the portfolio of most high earners. Real estate—particularly when financed with low, fixed-interest rate debt—also tends to beat inflation long term. Publicly traded REITs had a lousy 2022 (and a catastrophic 2008, falling 78% peak to trough), but their 15-year return (6.31% per year) still beats inflation. US stocks have had a great run over the last 10 years, but even if you go back 15 (to include 2008), they still made 8.71%. Even international stocks, despite the strengthening of the dollar lowering their returns the last decade, have at least mostly kept up with inflation (3.99% 10-year annualized return, 1.59% 15-year annualized return). Even bonds made 2.61% per year over the last 15 years, which beats inflation.

Stop trying to hedge against inflation in the short term and simply build a long-term portfolio that will outperform it. Stocks, bonds (including some inflation-indexed bonds), and real estate are all you need to outrun inflation during your investment career.

What do you think? Did anything work for you in 2022? How do you ensure your portfolio beats inflation? Comment below!