ETFs for Inflation: Everything You Need to Know

While there is not a specific inflation ETF category, there are types of ETFs that have generally outperformed the broader market indexes during periods of high inflation.

Learn more about how to invest during inflation, as well as the funds, sectors and asset types that can hedge against rising prices for consumer goods and services. 

What Is Inflation? 

Inflation is the increase in the prices of goods and services in an economy over time. There can be many factors that contribute to a rise in consumer prices, but the general cause of inflation is a surge in demand for goods and services without sufficient supply to meet that demand. 

A contributing factor to inflation can be an increase in money supply resulting from fiscal or monetary policy. For example, the historically high inflation from 2021 to 2023 was driven primarily by pandemic-related fiscal stimulus, combined with years of loose monetary policy in the form of low interest rates.

The COVID-19 pandemic also created supply chain disruptions, which, combined with post-pandemic pent-up demand, caused a dramatic surge in the prices of goods and services. 

How Does Inflation Affect Investments? 

Inflation is a normal aspect of a functioning economy. However, when inflation is abnormally high, it can result in declining prices for many different types of stocks and bonds. Yet some investment assets, such as certain commodities and inflation-protected securities, can outperform the broader market indexes during periods of high inflation. 

In general, high inflation negatively impacts the prices for most stocks and bonds. This is because the Federal Reserve will attempt to fight inflation by raising interest rates.

How Inflation Affects Stocks 

While stocks are generally good investments for fighting inflation over time, high inflation can negatively affect stocks in the short term. Higher rates generally cut into the profits of corporations by increasing their borrowing costs, thereby reducing profits.

Since higher interest rates make future cash flows look less attractive to investors, growth stocks tend to decline in price more than dividend-paying value stocks during periods of high inflation. 

How Inflation Affects Bonds 

Bond prices generally move in the opposite direction of interest rates, which means inflation is generally a bad environment for most fixed income securities. The longer the duration of the bond, the greater the sensitivity to a change in interest rates.

Therefore, when inflation is high and interest rates are rising, long-term bonds, and the ETFs and mutual funds that invest in them, can fall in price faster and further compared to short-term fixed income securities.

How to Invest During Inflation 

Determining how to invest during inflation is primarily dependent on an individual’s investment objective, which considers their time horizon and tolerance for risk. Based on historical trends, investments that can outperform the broad market indexes during high inflation include value stocks, commodities, and Treasury inflation-protected securities. 

Timeless investment strategies that can help reduce market risk during periods of high inflation include diversification of assets and dollar-cost averaging. Diversification involves the process of spreading risk across different asset classes, such as stocks, bonds and commodities, as well as a range of investment categories, such as different market capitalizations, sectors, and global exposure. 

What Is an Inflation ETF? 

An inflation ETF can be generally described as an exchange-traded fund that tracks an index or asset that may outperform other types of ETFs during high inflationary periods. A specific example is a TIPS ETF, which may track an index of Treasury inflation-protected securities that are linked to increases in inflation. Other examples include TIPS ETFs and dividend ETFs. 

ETFs that can outperform the broader market indexes during high inflation include: 

  • TIPS ETFs 
  • Dividend ETFs 
  • Commodity ETFs 

TIPS ETFs 

TIPS ETFs track an index of Treasury inflation-protected securities, which means the principal value of the underlying securities adjusts with movements in inflation. Investors should keep in mind that TIPS can decline in price when inflation is rising but weaker than expected. The largest TIPS ETF by assets under management is the iShares TIPS Bond ETF (TIP)

Dividend ETFs 

Dividend ETFs typically track the performance of a dividend index consisting of dividend-paying stocks of companies that pay high or stable and growing dividends. Dividend ETFs and other value-oriented ETFs generally outperform growth stocks during periods of high inflation, especially in the short term. The largest dividend ETF by AUM is the Vanguard Dividend Appreciation ETF (VIG).

The reason dividend ETFs and other value stock ETFs generally outperform growth stocks during high inflation is that inflation reduces long-term estimates for a company’s earnings and free cash flow. This favors dividend-paying companies over growth-oriented companies. In the long term, returns for value and growth stocks generally outpace the average rate of inflation.

Commodity ETFs 

Commodity ETFs are exchange-traded funds that seek to track the price movement of an underlying commodity or index. During periods of high inflation, the prices for commodities, such as oil, tend to rise. For example, the largest broad basket commodity ETF by assets, the Invesco DB Commodity Index Tracking Fund (DBC), rose approximately 18% in 2022, whereas the S&P 500 index declined by nearly 20%. 

Bottom Line 

Types of ETFs that can perform relatively well during periods of high inflation include TIPS ETFs, dividend ETFs, and commodity ETFs. However, investors should note that inflation ETFs are not guaranteed to gain in price when inflation is rising. Generally, the time-tested investment strategies of diversification and dollar-cost averaging are wise during adverse market conditions.

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