You are currently viewing How to invest during periods of high inflation

How to invest during periods of high inflation

Inflation.  It’s the boogeyman, the grim reaper, the silent killer of investors’ retirement dreams.  A recent survey by Leger showed that 84% of Canadians are worried about inflation.  Another survey south of the border revealed inflation as the top concern for 2022 – ranking well higher than the pandemic.  And there is reason to be fearful. 

Inflation represents a double-whammy of badness.  Everyone knows that inflation means higher prices, but history tells us that periods of high inflation are also associated with lower real returns for stocks and bonds.  Are you nervous about inflation?  Do you know how to invest during periods of high inflation?  Read this before changing your investment plan.

My inflation isn’t necessarily your inflation

The first thing to understand about inflation is that it is individual.    The most recent news is that Canada’s inflation rate just hit 5.1% – the highest it’s been since 1991.  This number represents the consumer price index (CPI) and it’s a hypothetical basket of goods and services that the average Canadian might expect to pay. 

But you might not be average.  Your personal inflation rate might be higher or lower.  Fortunately, there’s an app for that, The Personal Inflation Calculator, that will allow you to calculate your personal CPI.

Why CPI over-estimates real inflation

Just like our spending habits are individual, our responses to increasing prices are also individual.  The CPI assumes we’ll all keep buying the same stuff at the same places, but that’s not necessarily true.   When the price of beef is up 20%, while the price of fish is only up half that (which is the case, actually), a lot of people are going to eat more fish.  The same thing goes for the wine we drink, the clothes we wear and the cars we buy.  This is called item substitution and it’s something the CPI doesn’t account for.

The other thing the CPI doesn’t account for is vendor substitution.  When your weekly grocery bill at Whole Foods is up 15% and you’re feeling the squeeze, what do you do?  You start shopping at No Frills or Costco where the items are generally less expensive.

Because of these two responses to inflation, studies have shown that CPI overestimates real increases in the cost of living by about 0.5%.

Who is most vulnerable to high inflation?

Retirees are typically identified as the group most exposed to the ravages of inflation.  In fact, Gordon Pape recently wrote an article for the Globe & Mail entitled, “The worst nightmare for income investors is coming. Here’s how to prepare.”  He makes it sound like the zombie apocalypse. 

The reality may not be so sinister.  Why?  Because studies have shown that inflation-adjusted spending actually decreases during retirement by about 1% per year.  This means that if inflation is 2.5%, the average retiree’s spending will also increase, but only by about 1.5%.  This is called the “retirement consumption puzzle“.  Combined with the CPI’s over-estimation of real-life inflation, many retirees will feel the sting of inflation less than they might have anticipated.  And don’t forget, CPP and OAS are indexed to inflation, as measured by CPI. 

But still, there’s no getting around the fact that a prolonged period of higher-than-expected inflation could have a major detrimental effect on investors in terms of purchasing power and investment returns.

What should investors do?

High inflation is here and part of the reason it’s so scary is that we didn’t see it coming.  In fact, for a long time, the greater fear for policymakers was deflation, which would have been a far bigger problem for the economy.  This is what the CPI has done over the last two years.

It feels like inflation is going up and might keep on going up.  But inflation is a complicated beast, it’s unpredictable.  The truth is, we don’t know where inflation is going to be a year from now.  One of the many cognitive biases that humans suffer from is recency bias which causes us to give greater importance to more recent events.  In other words, recent events cause us to lose sight of the big picture.  To help you put recent inflation numbers in perspective, here is a chart of what CPI has done over the last 50 years in Canada:

As you can see, inflation can move sharply in either direction.  I’m not one to make predictions, but as life returns to “normal” and supply chain issues are resolved, there are certainly reasons to believe high inflation will also resolve.

In any case, there are two things to take away here.  First, inflation is unpredictable.  And, second, expected inflation is already baked into asset prices.  All of this data is known and markets are more or less efficient, so hedging against unexpected inflation must be framed accurately – it’s a gamble.

But, say you wanted to.  Say you wanted to protect yourself against inflation that is even higher than what is widely expected. What are your options?  Gold?  Crypto? Real return bonds?  A well-diversified portfolio of stocks?  Let’s look at these, one by one.


This shiny yellow metal has traditionally been considered a hedge against inflation, but as inflation has shot upward from its March 2020 lows, the price of gold has been relatively unchanged.


So, gold isn’t the answer.  Everyone and their dog is talking about crypto – what about that?


While cryptocurrencies are touted by some as the “new gold”, the verdict is out on whether or not they will serve as an inflation hedge.  So far, the results are not encouraging.  Over the last three months when inflation has been at its highest, the value of Bitcoin has dropped by 40%.  With six crashes of greater than 50% in the last ten years (and many more that were less than 50%), it’s definitely not the safe haven for me.

Real return bonds

Real return bonds are bonds issued by the government of Canada (TIPS in the U.S.) in which both the principal and interest payments are adjusted for inflation.  Sounds perfect, right? Not so much.  The big problem is that they are only a suitable hedge against inflation if your time frame matches that of the individual bonds, and their duration is very long (30 years).  Do you expect high inflation to last that long?

What about ETFs that hold real return bonds, like XRB?  Similar problem.  Unlike buying bonds directly, with a bond ETF you aren’t guaranteed your principal.  In a rising interest rate environment, the fund may have to sell bonds at a lower price than what they were bought for in order to manage the ETF.  Funds holding long-term bonds, like real-return bonds, are the most susceptible to losses.  XRB, for example, has a weighted average maturity of 18 years and has lost 8.7% over the last six months.

Don’t just do something, sit there

Let’s circle back and look at the well-diversified portfolio you had before everyone started talking about inflation.  Could your current plan still be the right one?  If it contains an appropriately diversified selection of equities, chances are your best move in response to higher inflation is to do nothing.

“But this is the highest inflation rate we’ve seen in thirty years and it could go even higher!  Why would I do nothing?”  Here’s why:

There are two problems with inflation: things cost more and investments tend to earn less.   

When things cost more we can either spend less or earn more.  Personally, I am choosing to pull both of those levers, but everyone has different levers within their reach.

What can we do about the fact that investments tend to do worse than average when inflation is high?  The first thing to realize is that investments, stocks in particular, still tend to have positive returns when inflation is high, so don’t sell your portfolio.

We can’t control what the markets do, but we can control how we invest, and when it comes to investing, there are three things we can do to weather the inflation storm we are in:

    1. Keep saving – every dollar you save now is a piece of your future you are taking control of
    2. Follow an evidence-based investment strategy – i.e. don’t try to pick hot stocks or time the market
    3. Minimize fees – because in investing, “you get what you don’t pay for”

If you would like to learn how to put these ideas into practice, I hope you will consider registering for the moneySmartMD course.

The bottom line

Financial events like high inflation can throw investors off balance, making us feel like we should do something.  I hope this post helps us remember that most of us should have already been investing with this possibility in mind and the best thing to do is to stick with our simple, evidence-based investment plan.  There is no magic bullet, no antidote to the uncertainty that inflation represents, but you can help yourself by keeping a level head, holding a diversified portfolio, and, if necessary, adjusting discretionary spending to a level you are comfortable with.

Please feel free to share your thoughts on investing during high inflation in the comments.

(Special thanks to Ben Felix and Cameron Passmore of The Rational Reminder Podcast.  Episodes 150 and 178 were important resources for this post.)

This Post Has 2 Comments

  1. Stefan Scott

    Great post, great reminders. Thanks Matt.

    1. Matt

      Thanks for the comment, Stefan!

Leave a Reply