In today’s financial landscape, finding reliable investments that offer a real return can be challenging. With inflation impacting the purchasing power of your money, it’s essential to focus on assets that can outpace rising costs. Real return refers to the actual gain on an investment after accounting for taxes and inflation.
Investors seek opportunities that can provide a real return. By understanding which investments align with these goals, you can make informed decisions to secure your financial future. Exploring options that maintain value while offering consistent returns is key to achieving long-term success.
Understanding Real Return
When you evaluate real investment returns, it is essential to consider how investments protect against inflation and reduce inflation risk. These aspects are crucial for maintaining the value and purchasing power of your investments over time.
Calculating Real Return
Real return is calculated by adjusting an investment’s nominal return for the impact of inflation, providing a clearer picture of the actual purchasing power gained or lost over time. The formula is straightforward: Real Return = Nominal Return – Inflation Rate. For example, if an investment yields a nominal return of 8% in a year with 3% inflation, the real return is 5%. This metric is essential for understanding the true growth of your portfolio, as it accounts for the erosion of value caused by rising prices, ensuring that your investments are genuinely increasing your purchasing power.
Battling Inflation Risk with Real Return Assets
Reducing inflation risk involves selecting investments that are less likely to underperform during periods of high inflation. Stocks are generally a good choice, as they represent ownership in companies whose revenues and profits can rise with inflation. You can examine stock returns and expected returns to identify stocks that perform well in varying economic conditions.
Another effective strategy is diversifying your investment mix. Including different asset classes can help mitigate potential losses in any single area. This balanced approach helps cushion against inflation risk, providing a more stable investment environment. Diversification allows some assets to perform well even if others are impacted adversely by inflation.
1) I Bonds
I Bonds represent a solid investment choice, especially if you are looking for safety and inflation protection. They are savings bonds issued by the U.S. Treasury, designed to keep pace with inflation.
I Bonds offer a composite rate that consists of a fixed rate and an inflation rate. The fixed rate remains constant for the bond’s life, while the inflation rate adjusts every six months. These bonds provide a hedge against inflation inherently and provide a real return with the fixed rate portion of the bond.
You can buy I Bonds directly from the U.S. Treasury’s website. They carry a minimum holding period of one year. If you redeem them before five years, you forfeit the last three months’ interest.
The investment limit for I Bonds is $10,000 per calendar year per individual when purchased electronically. There is also an opportunity to invest even more in I Bonds if purchased using a federal tax refund, allowing you to buy an extra $5,000 in paper bonds.
2) Gold
Gold is a popular investment choice for many due to its history and stability. Unlike stocks or bonds, gold is a tangible commodity that holds intrinsic value. Over time, investors have turned to gold as a hedge against inflation and currency fluctuations. Its value is often perceived as a safe haven during economic downturns.
When you invest in gold, you have several options. You can buy physical gold, such as coins or bars, or invest in gold mining stocks and gold exchange-traded funds (ETFs). Physical gold requires secure storage and insurance but gives you a tangible asset to hold. Gold ETFs track the price of gold and offer a convenient alternative for many investors.
The price of gold can be volatile, influenced by a variety of factors including geopolitical events, interest rates, and supply-demand dynamics. Despite this, its role in an investment portfolio is to provide diversification. Historically, gold has shown low correlation with other asset classes, reducing overall portfolio risk in uncertain times. Gold’s risk/return profile has made it important enough to warrant a 7.5% allocation in Ray Dalio’s All Weather Portfolio.
3) Real Estate
By investing in real estate, you own a real asset that has an intrinsic value based on its properties. By buying “real assets” like real estate and commodities, you can protect your portfolio from inflation as their price fluctuations are represented within the Consumer Price Index (CPI), whether it be directly or indirectly.
You might also consider investment in real estate debt. This involves lending money secured by real estate. You earn income through interest payments, and your investment is backed by the property itself, adding a layer of safety if the debtor fails to make complete and timely payments.
Another option in real estate is Real Estate Investment Trusts (REITs). REITs allow you to invest in real estate without the hassle of managing properties. They often pay dividends, providing a way to earn income.
It’s important to research thoroughly before investing in real estate. Consider factors like location, market trends, and property condition. Real estate can be a significant commitment, so ensure it aligns with your overall investment strategy.
4) Treasury Inflation Protected Securities (TIPS)
Treasury Inflation Protected Securities (TIPS) are an excellent option if you are looking to protect your investments from inflation. These bonds are issued by the U.S. government and are designed to increase with inflation, helping to maintain your purchasing power.
The principal value of TIPS adjusts based on changes in the CPI. When inflation goes up, the value of your investment increases. This means the interest payments you receive are also adjusted for inflation, ensuring you don’t lose buying power over time.
You might find that after-tax real returns on TIPS can be somewhat lower compared to other options. This is because the interest and inflation adjustments are both taxable. Some investors consider TIPS for their portfolio as a hedge against inflation, especially in times of economic uncertainty.
The liquidity of TIPS can vary based on their maturity. You can buy them in a range of maturities, including 5, 7, and 10 years. Understanding the role of TIPS yields in your overall portfolio strategy is crucial for optimal investment planning.
5) The S&P 500
The S&P 500 has historically delivered real returns over time, making it a cornerstone investment for building long-term wealth. Comprising 500 of the largest U.S. companies across diverse sectors, the index benefits from innovation, economic growth, and the consistent ability of these companies to generate earnings.
On average, the S&P 500 has provided an annual nominal return of around 9–10%, and even after accounting for inflation, the real return typically hovers around 6–7%. This consistent performance, combined with the power of compounding, allows investors to grow their purchasing power and accumulate wealth over decades, despite inflationary pressures.
One key reason the S&P 500 provides real returns is the ability of its constituent companies to pass on inflation-related costs to consumers and adjust to changing economic conditions. Many of these businesses have pricing power, enabling them to maintain profitability even as costs rise. Additionally, the index is dynamic, with underperforming companies removed and stronger ones added, ensuring that it reflects the evolving strength of the U.S. economy. By holding the S&P 500 over the long term, investors can achieve growth that not only keeps pace with inflation but also surpasses it, enhancing their real wealth over time.