How to invest during inflation

Inflation is a normal aspect of a growing economy. However, U.S. inflation jumped 8.5% in the past year, the most since 1981. Inflation doesn't just make trips to the store more expensive—it complicates investing as well.

Learning how to mitigate rising prices and how to invest during inflation can help you protect your finances against price increases.

Inflation is the general rise in the prices of goods and services over time. When prices rise, it decreases the purchasing power of money, and each dollar buys fewer goods and services. Put another way, the same goods and services cost more now than they did before.

This happens when an economy has too much money chasing after too few goods. In economics, this is described as the law of supply and demand. When consumer demand for goods and services is abnormally high, inflation typically rises at a faster pace than the historical average.

Inflation also can stem from an unusually low supply of goods and services, assuming the demand remains constant. When inflation rose to 40-year highs in 2022, supply chain disruptions reduced the supply of goods, while consumer demand stayed high, unemployment was low and households generally had more cash to spend.

There are multiple ways to help your financial strategy outpace inflation over time. As is always the case, investing involves risk. There are no guarantees—and investing during periods of inflation is no different. The general theory behind investing during inflation is to outpace the average rate of inflation over the long term. One generally acceptable inflation rate is around 2% or even a little lower; annualized returns for stocks have averaged about 10% historically.

Here are some time-tested saving and investing strategies to consider:

As an asset class, stocks have historically outpaced inflation. Hypothetically, say inflation runs above average—at 4% per year—for the next 20 years. Let's also assume your stock portfolio performs below average—at 8% per year—during that time. You're still doubling the rate of inflation, which means you're growing rather than shrinking your wealth.

Treasury inflation-protected securities(TIPS) tend to perform well despite inflation. These unique bond types are government securities that are designed to be indexed to inflation as measured by the Consumer Price Index (CPI).

Real estate investment trusts (REITs) are companies that own and operate income-producing real estate. Property values and rental income often rise along with inflation.

During times of uncertainty and rising prices, investors have historically used gold as a hedge. Keep in mind, though, that while gold is generally a stable asset, prices can fluctuate in the short term.

These are stocks of companies that sell items people need even during times of economic difficulty, such as health and food products. These investments are positioned to do well during inflationary periods; however, there's no guarantee they'll generate positive returns.

Diversification can help to reduce market risk during uncertain times. Because mutual funds are pooled investments that often hold dozens or hundreds of securities—stocks, bonds, cash or a combination of assets—in a single package, they can be smart diversification tools for any type of investor. Keep in mind that although diversification can reduce market risk, it does not guarantee a profit or protect against loss in a declining market.

If your employer offers a 401(k) with matching contributions, be sure to take advantage of this opportunity. For example, if your employer offers a 50% match for contributions up to 6% of your salary, try to contribute at least 6% of your pay. This is like getting a 50% rate of return on your investment, which is more than 10 times the average rate of inflation.

When you make periodic purchases with a set dollar amount, such as monthly 401(k) or other retirement contributions, you buy more shares of investments when prices are low and fewer shares when prices are high. Over time, this can average out and reduce market risk compared with investing a singular lump sum amount. This is called dollar-cost averaging, which involves continuous investing. Therefore, investors should consider their long-term ability to make purchases through periods of low prices and varying economic periods.

Bond yields and interest rates for certificates of deposit (CDs) typically rise during inflation, allowing investors to reduce interest rate risk and take advantage of higher interest rates by purchasing bonds or CDs with differing maturities.

For smart investment management, it's wise to periodically check to make sure your investments have the right mix to grow your money over time while minimizing short-term risk. You can do this yourself or with a financial advisor, who also can assess your risk tolerance, which describes your comfort level with the market's ups and downs.

Inflation isn't always bad. In fact, it's normally a positive sign of a growing economy. Inflation is generally considered good when it's lower than the historical average of 3.27% and bad when it's higher.

• Consumer confidence is growing. This positive outlook may fuel more economic growth.
• Interest rates are rising. For deposit accounts, this helps to grow savings rates.
• Higher prices are fighting off deflation. Price reductions (deflation) generally hurt an economy.

• Consumer and business confidence are falling. It creates uncertainty about the future and falling asset prices.
• Consumers have less purchasing power. This particularly harms people who have fixed incomes, like retirees.
• Interest rates are rising on loans and credit cards. This makes the cost of debt higher for consumers and businesses.

Although rises in the prices of goods and services are generally not within your control, you can implement some tips to offset the negative effects of inflation. These strategies focus on behaviors you can exert some power over, such as changing your spending habits:

• Save wisely. It's always smart to have an emergency fund to cover unexpected expenses. However, inflation will reduce the purchasing power of your dollars if you're not earning enough interest to keep up with rising costs.

• Spend wisely. As prices for goods and services increase, revisit your budget and look for areas to save money by spending less on items you don't need.

• Pay down credit card debt. When inflation rates rise, interest rates typically rise along with it. This means that variable-rate debt could increase and cost you more.

• Postpone large expenses. If possible, reduce or delay big-ticket purchases like home appliances, cars and large vacations.

• Shop smarter and negotiate prices. If you need to make certain purchases during high inflation, spend more time shopping for deals and consider negotiating prices whenever possible.

• Drive smarter. To reduce the impact of high gas prices, consider car pooling, consolidating several errands into one trip, or even walking or biking if possible.

Learning how to invest during inflation means pinpointing the strategies that work for each unique person and household. As you begin implementing an investment strategy for inflation, consider reviewing your budget and working with a local Thrivent financial advisor to ensure your investment portfolio is prepared for periods of high inflation.