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Stagflation, the unwelcome combination of high inflation and stagnant economic growth, can be a nightmare for investors.

Here are the 5 popular investments to beat Stagflation.

When the economy is experiencing Stagflation, traditional investment strategies may not be as effective, and navigating this treacherous financial landscape may feel like walking through a minefield.

In this blog post, we’ll explore the world of Stagflation and identify some of the best investments during these trying times.

Key Takeaways

• Stagflation is a complex economic challenge, so countercyclical investments like commodities, defensive stocks, and real estate are the best assets to invest in.
• Diversifying your portfolio with value & cyclical stocks can help reduce risk & maximize returns during Stagflation.
• Avoid risky investments such as growth stocks and bonds during this period.
• Best stagflation investments: Commodities and precious metals, defensive stocks, real estate, and REITs.

What is Stagflation?

So, what exactly is Stagflation?

Put simply, it’s a situation in which economic growth is low (stagnant) and inflation is high simultaneously.

This toxic combination of slow economic growth and rising prices can pose a significant challenge for investors.

Traditional investment strategies may not yield the intended results. Stocks tend to underperform due to slow economic growth, and bond returns are diminished because of high inflation and fluctuating interest rates.

There are several economic theories about what causes Stagflation, but that goes beyond the scope of this article.

The 1970s served as a prime example of the devastating impact of Stagflation on the global economy.

The World Bank indicates that families with low or fixed incomes and retirement savers are often hit the hardest during this period.

Best Assets to Invest in During Stagflation

In times of Stagflation, it is smart to prioritize assets like commodities, defensive stocks, and direct investments in real estate or REITs.

These assets can provide stability and potential growth, helping you maintain healthy investment portfolios despite economic uncertainty.

1. Commodities and Precious Metals

Commodities like gold, oil, precious metals, and agriculture tend to perform well during Stagflation, and there are several logical explanations why:

1. Hedge Against Inflation: Commodities like gold, oil, and agricultural products typically serve as a hedge against inflation. During stagflation, inflation rates are high, and commodities can provide a buffer against the eroding value of currency.
2. Supply Constraints: Stagflation occurs when economic growth is stagnant, but inflation rises. In such periods, the supply of goods often becomes constrained, which can drive up the prices of commodities.
3. Non-Correlation with Stocks: Commodities often have a low or negative correlation with stocks, making them a good diversification option. This is particularly useful during Stagflation when equities often perform poorly.
4. Global Demand: Commodities can also be influenced by demand on a global scale. Even if a specific economy faces stagflation, global demand can increase commodity prices.
5. Tangible Assets: Commodities are considered “real assets,” meaning they have a tangible physical form, e.g., gold coins. Real assets often perform well during inflation because their value is not just a financial abstraction.

Invesco DB Commodity Index Tracking (DBC) is an example of an exchange-traded fund that provides exposure to commodities such as energy, agriculture, and base metals. This ETF could be researched to see if it is a good Stagflation investment.

NOTE: Compared to equities, commodities were a boon for investors during the 1970s. The chart below shows real and nominal returns of commodities during this period, which was widely known as one of the most significant periods of stagflation.

According to Kiplingers, the S&P GSCI Index, a measure of commodities investment performance, returned 586% between 1970 and 1979.

2. Defensive Stocks

Defensive stocks, also known as non-cyclical stocks, are those in the consumer staples and healthcare sectors that can provide stability and potential growth during stagflationary periods.

From a quantitative perspective, defensive stocks have a beta of less than 1. This means that if the stock market falls, cyclical stocks will outperform the market, making them excellent stagflation investments.

There are several reasons defensive stocks are considered good investments during periods of stagflation:

1. Stable Demand: These stocks belong to industries with relatively inelastic demand, such as healthcare, utilities, and consumer staples. Even in tough economic conditions, people still need to eat, use electricity, and seek medical care, making their demand stable.
2. Dividend Yields: Defensive stocks often provide steady dividends. When capital gains from stocks are uncertain, these dividends offer a consistent income stream for investors making them popular during Stagflation.
3. Lower Volatility: These stocks are generally less volatile compared to the broader market, offering some level of protection against market downturns (why are they less volatile)
4. Cash Flow: Companies in defensive sectors often have strong and predictable cash flows. This enables them to weather economic downturns more easily compared to cyclical companies.
5. Price Insensitivity: Consumers are less sensitive to price changes for essential goods and services. This helps maintain revenues for companies in defensive sectors during inflationary periods.
6. Hedge Against Uncertainty: In times of economic instability or stagflation, investors often seek safer, less volatile investment options. Defensive stocks can serve as a hedge against economic uncertainty.
7. Portfolio Diversification: Including defensive stocks in a portfolio can help in diversification, reducing the overall risk during economic downturns, including stagflation.
8. Lower Debt Levels: Defensive companies often operate with lower levels of debt compared to cyclical companies, making them less sensitive to interest rate changes, a common occurrence in stagflation.

As indicated by a Schoreders study, utilities, and consumer staples are the best performing stocks during a stagflationary environment.

Meanwhile, cyclical stocks such as IT and industrials are some of the worst performers during Stagflation.

Allocating funds to defensive stocks can safeguard your portfolio from the adverse impacts of Stagflation.

3. Real Estate and REITs

Real estate investments, including rental properties and publicly traded REITs, can serve as a hedge against inflation and provide reliable returns during Stagflation.

Historically, real estate has been one of the top-performing assets during Stagflation because it can offer tangible value and help protect your money from inflation.

3 Reasons why real estate and REITs make good Stagflation investments:

1. Tangible Asset: Real estate is a tangible asset, which makes it less susceptible to inflation’s erosive impact on purchasing power. The intrinsic value of property often remains stable or even increases during inflationary periods.

For example, The FTSE Nareit Index, which is a market capitalization-weighted index of U.S. equity REITs,  gained 100% in total return between 1971, when data was first available, to the end of 1981.

2. Interest Rate Sensitivity: Although stagflation often leads to higher interest rates, real estate investments that were acquired with fixed-rate mortgages can benefit from having locked-in lower payments while rental income and property values are rising.

3. Consistent Rental Income: Real estate properties can generate a steady stream of income and landlords can increase rental prices during inflationary periods, making it an ideal investment during Stagflation when other investments may be underperforming.

In addition to directly investing in real estate, investing in Real Estate Investment Trusts (REITs) can also provide exposure to the real estate market and the potential for stable returns during Stagflation.

You can invest in physical real estate through popular real estate crowdfunding platforms like Fundrise and Groundfloor. Or, invest in popular publicly-traded REITs through your online brokerage account.

4. Treasury Inflation-Protected Securities:

Another popular Stagflation investment is Treasury Inflation-Protected Securities, known as TIPS. These securities are government treasury securities that provide a real return that is linked to the Consumer Price Index, which is the widely accepted benchmark for inflation.

During times of Stagflation, you can at least get returns that are on par with inflation, thus keeping your investment portfolio protected.

You can invest in TIPs directly through the TreasuryDirect website, or through an ETF like the iShares TIPS Bond ETF.

5. Short Selling Cylical Equities

A less common way to invest during inflation is to short-sell cyclical equities. Cyclical equities are stocks of companies that produce or sell items that are considered non-essential – like an iPhone. So in times difficult economic times, individuals will be less likely to buy non-essential items like a new car, or television.

Cyclical sectors have a market beta of greater than 1, meaning they generally underperform when the stock market falls, thus presenting a short-selling opportunity.

Short selling is an investment strategy where an investor borrows shares of a stock from a broker and sells them in the open market, with the intention of buying them back later at a lower price. The goal is to profit from the decline in the stock’s price.

Here’s how it works in simple terms:

1. Borrow Shares: The investor borrows shares of a stock they believe will decrease in value.
2. Sell Shares: The borrowed shares are then sold in the open market at the current price.
3. Buy Back Shares: If the stock price declines, the investor buys back the same number of shares at a lower price.
4. Return Shares: The investor returns the borrowed shares to the broker, keeping the difference between the selling price and the buying price as profit.
5. Risk: If the stock price increases instead of declining, the investor will incur a loss when buying back the shares at a higher price.

The strategy is considered high risk because the potential for loss is theoretically unlimited; a stock’s price can rise indefinitely, leading to mounting losses for the short seller.

Some popular cyclical stocks include Disney and Expedia.

Diversifying Your Portfolio for Stagflation

Diversification, a vital element in any successful investment strategy, is even more important during Stagflation.

Spreading your investments across various assets or asset classes can lower your portfolio’s overall risk and potentially amplify your returns.

A well-diversified portfolio that includes a mix of value and cyclical stocks can help protect your investments during Stagflation.

Value stocks, which trade at a lower price compared to their underlying fundamentals, can offer long-term growth potential during economic downturns.

Meanwhile, cyclical stocks, which follow economic cycles, can present opportunities to buy low and sell high as the economy rebounds from Stagflation.

Investing in both stock types can mitigate loss risks and boost your returns during these tough times, as stock prices may fluctuate.

Value Investing

Value investing is an investment strategy that focuses on undervalued stocks with strong fundamentals, offering long-term growth potential during economic downturns.

By identifying and investing in undervalued securities, you can take advantage of opportunities for greater returns than the general market and potentially reduce the risk associated with your investments.

Nonetheless, awareness of the risks accompanying value investing is crucial. The stock might not bounce back in value, or it could become overpriced, leading to potential losses.

Cyclical Stocks

Cyclical stocks are those that tend to follow economic cycles, with their prices impacted by changes in the economy.

These stocks usually perform well during periods of economic growth but may not do as well during recessions. However, during Stagflation, cyclical stocks can offer opportunities to buy low and sell high when the economy rebounds, potentially providing attractive returns for investors.

Allocating funds to cyclical stocks during Stagflation can be lucrative, but cognizance of the strategy’s associated risks is vital.

Investments to avoid during Stagflation

According to a recent article from the Economist, during years of high inflation, stocks and bonds performed poorly. The article highlighted that between 1900 and 2022, bond returns turned negative when inflation was above 4%.

Meanwhile, stocks also went negative when inflation rose above 7.5%. During times of stagflation, it’s paramount to steer clear of investments that could fall susceptible to stagflation.

3 investments to avoid during Stagflation:

• Growth stocks: Often trade at high valuation multiples. so during times of Stagflation, investor sentiment often turns negative, making these high valuations difficult to sustain.
• Bonds: Most bonds pay a fixed interest rate. During times of high inflation, interest rates tend to increase. As a result, the yield on the fixed-rate bond is not as appealing to investors, thus causing the price of the bond to fall, which makes them poor investments during stagflation.
• Cash equivalents: They may also lose value over time due to inflation, making them less effective as a hedge against rising prices.

Instead, focus on assets that have historically performed well during Stagflation, such as commodities, defensive stocks, and real estate.

By concentrating on these types of investments, including stagflation stocks, you can minimize the risks associated with investing during Stagflation and potentially maximize your returns.

Preparing for Stagflation: Financial Planning Tips

Beyond managing your investment portfolio, other financial planning measures can be taken to brace for Stagflation.

Reducing your debt and improving your credit can help you weather the storm of Stagflation and emerge on the other side in a stronger financial position.

Maintaining a diversified portfolio, as discussed earlier, is also crucial for mitigating the risks associated with Stagflation and maximizing your returns.

By taking a proactive approach to financial planning and seeking professional investment advice, you can better prepare yourself for the challenges of Stagflation and ensure that your financial future remains secure.

Final Thoughts

Stagflation presents unique challenges for investors, but with the right strategies and a well-diversified portfolio, it’s possible to navigate these turbulent times and even come out ahead.

By focusing on assets that have historically performed well during Stagflation, such as commodities, defensive stocks, and real estate, you can protect your investments and potentially achieve attractive returns.

Diversifying your portfolio with a mix of value and cyclical stocks can further reduce risk and maximize your returns during these challenging economic conditions.

By avoiding risky investments, implementing strategies like short-selling, and seeking professional financial advice, you can prepare for Stagflation and ensure that your financial future remains secure.

Remember, the key to success in any economic environment is adaptability, so stay informed, stay agile, and keep your eyes on the prize.

Frequently Asked Questions

What shares do well in Stagflation?

Stocks such as ExxonMobil, Chevron, Pfizer, Cisco Systems, United Parcel Service, gold, energy stocks, agricultural stocks, and real estate tend to perform well during periods of Stagflation.

What is Stagflation?

Stagflation is a troubling economic situation in which economic growth is low and inflation is high, posing difficult challenges for investors.

How can I diversify my portfolio during Stagflation?

To diversify your portfolio in a stagflationary environment, invest in a mix of value and cyclical stocks to safeguard your investments and maximize returns.

What investments should I avoid during Stagflation?

In Stagflation, it’s best to avoid growth stocks, bonds, and cash equivalents. They have the potential to stay stagnant or even lose their value.

What are some strategies for navigating Stagflation?

Navigating Stagflation can be accomplished by short-selling, focusing on real assets, and investing in sectors that have shown strong performance historically.

Understanding the differences between index funds and mutual funds is critical to making informed investing decisions.

Understanding the differences between index funds and mutual funds is critical to making informed investing decisions.

These funds follow different investment strategies – passive for index funds and usually active for mutual funds – affecting potential returns and risk levels. Costs also differ, with index funds generally having lower fees due to passive management. Thus, knowing these distinctions can help align your investments with your financial goals, risk tolerance, and cost preferences.

Quick Comparison:

What are Index Funds?

Index funds are an investment fund – usually referring to an exchange-traded fund (ETF) like VOO or SPY. Index funds aim to replicate the performance of a specific market index like the S&P 500, the Dow Jones Industrial Average, or other global and sector-specific indexes.

There are several pros and cons of index funds, but the goal of an index fund is not to outperform the market but to match the returns of the chosen index with minimal tracking error. This is why index funds are considered a type of passive investment; they essentially mirror the market index they track.

Investing in an index fund means you’re spreading out your investment across all the assets in that index, providing a level of diversification. Due to their passive nature, index funds usually have lower expense ratios than actively managed funds, making them a cost-effective choice for many investors.

However, like all investment options, index funds come with their own risks, including market risk. The fund’s value will rise and fall with the index it tracks, meaning if the index falls in value, so too will the index fund.

What are Mutual Funds?

Mutual funds are a pooled investment vehicle consisting of a portfolio of stocks, bonds, or other securities. Mutual funds are managed by professional fund managers who allocate the fund’s assets to provide above-average returns for its investors.

Each investor in the mutual fund owns shares representing a portion of the fund’s holdings. The performance of a mutual fund is directly related to the performance of the securities it purchases. 

Mutual funds offer small or individual investors access to diversified, professionally managed portfolios of equities, bonds, and other securities, which would be pretty difficult to create with a small amount of capital.

Mutual funds do not actively trade throughout the day like stocks and ETFs. They are bought and sold once a day, at their Net Asset Value (NAV), which is simply the fund’s total assets – total liabilities.

Head-to-Head Comparison

While mutual funds and index funds may seem similar at first glance, there are several key differences between these investment options.

Active vs. Passive Management

The primary difference between index funds and mutual funds is how they are managed.

Index funds are typically passively managed, while mutual funds are usually actively managed. 

Passive management aims to mirror the performance of a specific market index rather than trying to beat it. Index funds, for example, are passively managed and seek to replicate the holdings and performance of their benchmark index.

Meanwhile, active management involves a fund manager or a team making specific investment decisions for the fund, with the goal of outperforming a specific benchmark index. This includes researching and selecting the securities to buy, hold, or sell, and adjusting the portfolio based on market conditions.

Due to this hands-on approach, actively managed funds usually have higher expense ratios, which can eat into returns. They may also generate more capital gains distributions, which can have tax implications. However, the potential for above-average returns may be appealing to some investors.

Because they aren’t actively trading securities and require less day-to-day management, index funds generally have lower expense ratios. This can be an advantage for investors who are mindful of costs. But it’s important to remember that index funds will not outperform the market — they aim to match it. If the market goes down, the index fund will go down as well.

Fees

When it comes to fees, one of the key differences between index funds and mutual funds lies in their management style, which significantly influences their cost structures.

Mutual funds are typically actively managed, meaning a fund manager or a team actively makes decisions about which securities to buy and sell in an attempt to outperform the market. This active management requires more effort, research, and transaction costs, all of which lead to higher expenses. These costs are passed onto investors in the form of higher expense ratios.

The average expense ratio for an equity mutual fund was 0.44% in 2022, according to the Investment Company Institute, a trade association for the U.S. Investment industry.

Index funds, on the other hand, are passively managed. They aim to mirror the performance of a specific market index and therefore require less buying and selling of securities. This passive management results in lower transaction costs and lower fund management expenses. Consequently, the expense ratios of index funds are typically significantly lower than those of actively managed mutual funds.

In 2022, the average index fund fee for exchange-traded funds was just 0.16%.

And while lower fees can be appealing, they’re just one factor to consider when choosing an investment. The goal is not to pay the lowest fees possible but to find the best value – that is, to find funds that offer the best combination of returns, risk, and costs that align with your investment goals and risk tolerance.

Minimum Investment

Minimum investment requirements differ between index funds and mutual funds and can also vary considerably among different fund companies.

Many mutual funds have minimum initial investment requirements. This is the minimum amount you need to invest to open a new mutual fund account. It can range from as low as $1,000 to as high as $10,000 or more. Some mutual funds may waive or lower their minimum investment requirement if you agree to automatic, regular investments.

Meanwhile, index funds like VOO or VTI have a minimum investment of just 1 share.

Remember that it’s crucial to consider other factors beyond minimum investment when choosing between mutual funds and index funds, such as your investment goals, risk tolerance, and the fund’s expense ratio and historical performance.

Returns

The returns of index funds and mutual funds largely depend on their investment strategy, market conditions, and the skills of the fund managers in the case of mutual funds.

Mutual funds are usually actively managed, with fund managers selecting investments with the goal of outperforming a specific benchmark index.

If the managers are skillful and market conditions are favorable, these funds have the potential to deliver higher returns than the market average.

However, mutual funds can also underperform the market if the manager’s decisions do not pan out as expected.

According to a recent article from the NYTimes, not one of 2,132 actively managed funds outperformed the market over the past 5 years.

It’s also important to note that the higher fees associated with actively managed mutual funds can erode returns over time.

Index funds are passively managed and aim to mimic the performance of a specific market index. They do not seek to beat the market, but to match it. Therefore, the returns of an index fund should be very close to the returns of its benchmark index, minus a small amount to cover management fees.

Taxes

Tax implications are another important aspect to consider when comparing index funds and mutual funds. Both types of funds are subject to taxes, but the frequency and magnitude of taxable events can differ significantly due to their management styles.

Mutual funds are typically actively managed, meaning a fund manager is regularly buying and selling securities within the fund to achieve its investment objectives. Each time a security is sold for a gain within the fund, a taxable event occurs. This can lead to more frequent capital gains distributions to shareholders, which are subject to capital gains tax. Shareholders must pay taxes on these distributions in the year they are received, even if they are automatically reinvested.

Index funds are passively managed to track a specific market index, which usually results in lower turnover of securities. This means fewer taxable events, typically leading to fewer capital gains distributions. As a result, index funds can be more tax-efficient than actively managed mutual funds.

In both cases, any dividends received and any capital gains realized when you sell your fund shares are also taxable. However, the tax treatment of these earnings can be affected by several factors, including how long you’ve held the shares and the type of account in which the shares are held, for example, a brokerage account vs. Roth IRA.

It’s recommended to consult with a tax advisor to understand the full tax implications of investing in mutual funds or index funds.

How to Pick The Right Option

When choosing between an index fund and a mutual fund, there are several factors one must take into consideration, such as investment goals, risk tolerance, costs, and time commitment.

Investment Goals

Your investment objectives will guide your choice.

If you aim to beat the market and are willing to take on additional risk, then actively managed mutual funds might suit you.

However, if your goal is to match the market’s performance with less risk and cost, then index funds could be a better option.

Risk Tolerance

Mutual funds can offer the potential for higher returns, but they also come with higher risk due to active management strategies. Conversely, index funds can provide more predictable performance closely following the market index, thus reducing specific fund manager risk.

Costs

Index funds tend to have lower expense ratios due to their passive management strategy.

On the other hand, mutual funds usually have higher fees due to the active role that fund managers play.

Over time, these costs can significantly impact your returns.

Tax Considerations

Mutual funds may generate more frequent capital gains due to active trading, leading to potentially higher taxes for investors. Index funds usually have fewer taxable events due to their passive management, making them more tax-efficient.

Minimum Investment

Some mutual funds require a minimum initial investment which can be a barrier to entry for some investors. Many index funds have lower minimum investments, making them more accessible to a wider range of investors.

Time Commitment

 If you’re interested in closely following your investments and are comfortable with potentially more volatility, an actively managed mutual fund could be suitable. If you prefer a “set it and forget it” approach, an index fund could be a better choice.

Always remember, it’s important to carefully review the prospectus of any fund you’re considering and perhaps consult with a financial advisor to ensure the choice fits your overall investment strategy and financial goals.

The Bottom Line

Understanding the distinctions between index funds and mutual funds is crucial for savvy investing. Index funds are passively managed and aim to mirror the performance of a specific market index, providing a cost-effective and diversified investment option.

On the other hand, mutual funds are actively managed by professionals seeking to outperform the market, offering the potential for higher returns at the cost of higher fees and risk. Costs, investment goals, risk tolerance, tax implications, minimum investment requirements, and time commitment are critical considerations when deciding between the two. It’s essential to align your choice with your overall financial goals and strategy.