With inflation at 9% or higher (depending on the numbers you believe), it may be too late to profit from the increase, but it makes sense to re-construct your portfolio to reduce the impact.
My plan, which I detail in this post, is a mix of reading and personal experiences. Ofcourse everyone has a unique situation, so my approach may not be valid for everyone. However some points may be of use to most of you.
1. Equity is one of the best hedges against inflation. Long term returns are definitely 12% + (I don’t think 40% is the norm unlike the last few years). If one can find and invest in good companies, one’s with strong competitive advantage and pricing power, then I think the returns will definitely be more than inflation. Ofcourse in the short run one can lose money, so equity is not hedge against inflation in short term.
2. Debt is usually a component of one’s portfolio. In period of rising inflation it makes sense to invest in floating rate funds. That way one is hedged against inflation and may get a return of 1-2% above inflation. However with the current lose monetary policy and low interest rates, the real returns from such funds may be negative. It is likely that the benchmark rates will be raised in response to the inflation. In such a scenario, floating rate funds may give returns slightly above inflation.
3. Avoid long term FD’s and such commitments. If you invest for 5 years at say 8%, and if inflation crosses 9-10%, then you are losing money. One option can be to break the deposit and re-invest, but there is generally a penalty and loss associated with it.
4. Real estate is good hedge especially if funded by a fixed rate loan. In hindsight 2003-2004 was a great time to invest in real estate. Interest rates were low, everyone thought inflation was gone and real estate seemed to be priced reasonably. However I am not sure how good real estate is now as an investment option in general.
5. Be good at your job/ profession etc . Now this is a non-financial advise, but in the end for most of us the biggest asset is our skills. I think constantly upgrading skills and doing well in our professions is one of the best hedges against inflation. If you are one of the top performers, you will earn more via better increments or higher profits from your business. So I think investing in yourself is one of best hedges against inflation.
Now a lot of people will say gold, metals etc. I personally have no interest in those options. The long term data in most of these options show that the returns track inflation. So in absence of some special understanding of these alternative asset classes, I prefer to avoid them. I think there is enough for me to do in equity and debt than to worry about all this other stuff.
Finally, I mentioned profit from inflation ..is that possible ? if you can fund a long term asset such as real estate with a fixed debt (when rates are low) then during inflationary periods the rental rises with the inflation whereas debt is fixed. So equity in the asset is rising faster than inflation.
Also if you can roughly estimate when inflation is peaking, an investment in long duration debt (such 10 year bonds or mutuals) will give good returns when inflation slows (due to repricing of bonds). This happened to investors during the 2000-2003 time frame.