How to Protect Your Portfolio Against Inflation: Real Assets vs. Equities

How inflation affects different investments

The key distinction is between nominal and real returns. Real return equals nominal return minus inflation, approximately. Cash and conventional bonds pay fixed nominal amounts, so unexpected inflation reduces their real value directly. Rising inflation also tends to push interest rates higher, lowering the prices of existing bonds.

Assets with cash flows or prices that can rise with inflation, such as businesses that can raise prices, rents linked to inflation or commodities whose prices feed into inflation itself, have better potential to keep pace. How well they do in practice depends on the speed and cause of the inflation.

Inflation-linked bonds

Inflation-linked government bonds offer the most direct protection. In the United States, Treasury Inflation-Protected Securities adjust their principal with the Consumer Price Index, and interest is paid on the adjusted principal. If held to maturity, they preserve purchasing power relative to the index, plus their real yield.

US Series I savings bonds offer a related approach for individual savers, combining a fixed rate with an inflation rate that resets every six months, subject to annual purchase limits. Inflation-linked bonds can still lose value before maturity when real interest rates rise, as many did in 2022, so they protect against inflation more reliably than against rate changes.

Real assets: property, infrastructure and commodities

Real assets are physical or tied to physical activity. Their appeal during inflation comes from the possibility of rising income or prices as costs rise. Each type behaves differently, as summarized below.

• Real estate: rents can rise with inflation over time, though property values are sensitive to higher mortgage and borrowing rates.
• Infrastructure: assets such as toll roads and utilities often have contracts or regulated prices linked to inflation.
• Commodities: energy, metals and agricultural prices have often risen during inflation surges, but they are volatile and produce no income.
• Gold: traditionally viewed as a store of value, with a mixed record as a short-term inflation hedge and strong sensitivity to real interest rates.

Equities as a long-term inflation hedge

Stocks represent ownership of businesses whose revenues and profits are measured in nominal terms. Over long periods, companies that can raise prices have generally grown earnings faster than inflation, which is why equities have historically delivered positive real returns over multi-decade horizons.

In the short run the picture is less favorable. Sudden inflation surges often hurt stocks, because higher interest rates reduce the present value of future profits and rising input costs squeeze margins. Companies with pricing power, strong balance sheets and modest capital needs have tended to cope better than highly indebted or long-duration growth companies during such periods.

Reading market inflation expectations

Markets publish their own inflation forecast every day. The breakeven inflation rate is the difference between the yield on a conventional Treasury and the real yield on a TIPS of the same maturity. If the 10-year Treasury yields 4.2 percent and the 10-year TIPS yields 1.9 percent, the breakeven is 2.3 percent.

The figure is useful for choosing between the two. If inflation over the period ends up above the breakeven, TIPS would have outperformed the conventional bond; if it ends up below, the conventional bond would have done better. Breakevens also contain risk and liquidity premiums, so they are an approximate gauge rather than a pure forecast.

Comparing the options

Each tool has a different job. Inflation-linked bonds protect the real value of known future needs. Commodities can respond quickly to inflation shocks but are volatile and have long stretches of poor returns. Real estate and infrastructure offer income that can grow with prices, with sensitivity to interest rates. Equities provide the strongest long-term real growth, with short-term vulnerability.

A blend generally works better than a bet on one asset. Many investors keep equities as the long-run growth engine, hold some inflation-linked bonds for stability in real terms and add a modest allocation to real assets for diversification.

Practical steps for investors

Inflation protection starts with planning rather than with a single purchase. The steps below help align a portfolio with the risk that rising prices pose to specific goals.

• Express long-term goals in real terms, so plans already assume prices will rise.
• Avoid holding more cash than needed for emergencies and near-term spending.
• Match inflation-linked bonds to known future expenses, such as retirement income needs.
• Keep bond duration aligned with your horizon to limit damage from rising rates.
• Review allocations after major shifts in inflation, without chasing whatever performed best recently.

The bottom line

The best defense against inflation is a diversified portfolio with enough growth assets to outpace rising prices over time, supported by assets that respond directly to inflation. Trying to time inflation cycles with large shifts between asset classes is difficult, and costs and taxes can erase the benefit.

Inflation's effects compound, and so do the effects of a sensible plan. All investments carry risk, including loss of principal, and this guide provides general education rather than individual advice.