Portfolio manager sees opportunity in rising dividend stocks
If you buy food or gas like everyone else, you already have a profound understanding of how inflation can consume your budget.
The latest official inflation tally showed a jaw-dropping 3.4 per cent increase in the cost of living in April compared with a year earlier.
That’s not to say runaway inflation is inevitable. The Bank of Canada has vowed to use its monetary bag of tricks to keep it under control. Also, if you draw income from a defined benefit pension (DB), Canada Pension Plan (CPP) or Old Age Security (OAS), benefits are automatically tied to inflation.
Canadians who invest through a defined contribution pension (DC), or through a self-directed registered retirement savings plan (RRSP) or tax-free savings account aren’t so lucky. But there are steps you can take in your investment portfolio to hedge against a rapid increase in the cost of living. The objective of a hedge is to add protection without sacrificing return potential. Here are four ways to put that protection in your portfolio.
1. Commodity equities
Equity markets generally advance with inflation (to a point), so it’s good to stay invested and diversified across sector and geographic lines. But some equities actually contribute more to - and benefit more from - inflation. Commodities like crude oil, lumber, grain and metals have taken the lead. That means bigger profits for commodity producers.
You can invest in specific commodities on the futures market through exchange-traded funds (ETFs), or purchase shares in commodity-producing companies directly or through ETFs and mutual funds.
2. Real estate
Real estate is another equity asset class already contributing to - and benefitting from - inflation. Home owners are reaping rewards from soaring residential real estate prices but there are many ways to diversify real estate holdings into other real estate subsectors through real estate investment trusts. REITs are companies that own and operate residential, commercial and industrial real estate that generate income from rents and capital gains through price appreciation.
3. Short-term fixed income
Proper portfolio diversification includes safe fixed income, such as government bonds. Dedicating a significant portion to fixed income in a portfolio will cushion it from volatility on the equity side. How much of your portfolio should be dedicated to fixed income depends on your tolerance for risk and how soon you need the cash.
It’s hard to make that argument right now when yields are near rock-bottom lows, so it’s best to bite the bullet for now and keep your fixed income in short-term maturities to take advantage of higher yields if inflation pushes interest rates up. A typical one-year guaranteed investment certificate (GIC), for example, pays about one per cent (well below the current inflation rate).
You can also hedge fixed income with inflation-adjusted products such as annuities or real return bonds, but the added cost of that protection could eat into overall returns if inflation does not become a problem.
4. Fixed-rate mortgage
Variable-rate mortgages are now available at about one per cent. While it might be tempting for homeowners to borrow money for (close to) nothing, a rapid rise in mortgage rates could translate into hundreds of dollars added to a monthly household budget or tens of thousands of dollars over the course of the mortgage.
Five-year fixed rates are available at two per cent. That means you will pay two per cent no matter what inflation does to mortgage rates in the next five years.
If you aren’t already locked in, think about locking in now.