What ETFs Will Pop with Inflation?

“Inflation takes from the ignorant and gives to the well informed.” — Venita Vancaper, Author

One primary concern that remains on investors’ radar is inflation. If inflation runs riot, prices soar and consumers have less money in their pockets to buy discretionary good, go on vacations, and travel. But inflation can also cause assets to balloon in price. So which ETFs are best suited to protect your portfolio if inflation runs rampant? 

First, here’s a quick primer on why inflation matters.

The Impact of Inflation on Investments

The concept of inflation is something we’re all familiar with, defined by the rise in the cost of consumer goods and services. Simply put, inflation erodes the buying power of your money over time. In some cases, inflation can indicate a growing economy. However, if inflation rises too quickly, it can threaten corporate profits.

When aiming to protect your portfolio, step one is to learn about inflation and how interest rates influence your current and future investments based on the current (and forecasted) economic environment. 

For example, bonds are typically the most vulnerable to inflation because payments are typically tied to fixed interest rates. In contrast, stocks can add protection, as companies have the power to increase the price of goods and services in response. However, when companies absorb higher pricing and slow sales, share prices begin to dip. 

As interest rates spike, so too does the cost of borrowing. These cost increases result in consumers spending less. 

To address inflation risk, here are a few tips:

• Focus on variable-rate investments where payments are based on an index. An example would be prime rates, which are affected by the rise and fall of inflation. 
• Consider inflation-linked bonds, as returns are tied to the cost of consumer goods. 
• Diversify your portfolio. If you’re investing for the long-term, pay attention to your goals and the risks of those goals. 

Here are three ETFs that can help protect your portfolio against inflation. 

1. Financial Select Sector SPDR Fund (XLF)

The Financial Select Sector SPDR Fund (XLF) covers a variety of companies within the financial sector.

With over $45 billion in assets, some of ETFs top holdings include Warren Buffett’s massive conglomerate, Berkshire Hathaway Inc., and JP Morgan Chase & Co., the banking giant. 

As interest rates increase, investing in financial firms is generally regarded as a good move. These firms will likely increase the rates they charge, yet the firms themselves have borrowed capital at a lower rate based on previous market conditions. 

Past performance shows the potential of this ETF. By December 2021, XLF reported a return of 34.03%, making its three-year average annual return 18.37%. 

2. Fidelity Low Duration Bond Factor ETF (FLDR)

Another strategy is to take a more defensive approach, navigating rising interest rates by relying on bonds with a lower duration. This is the amount of time it would take for you to recoup your original investment. Investors need to know how interest rates influence newer bonds vs. older ones related to a bond’s maturity. 

What makes Fidelity Low Duration Bond Factor ETF (FLDR) attractive is that bonds mature rather quickly and are linked to low-risk investments in the U.S. Treasury or in top corporations.

For example, when investing in Treasury inflation-protected securities (TIPS), you get access to government-guaranteed fixed-income instruments. ETFs that invest in TIPS provide protection against the erosion of purchasing power due to inflation. 

The yield isn’t particularly high, but the idea here is to obtain a solid foundational investment. 

3. iShares Floating Rate Bond ETF (FLOT)

Speaking of bonds, bond funds can be a great choice during a rising interest rate environment. If this is something you’re interested in, iShares Floating Rate Bond ETF (FLOT) is one of the best ETFs you can consider now.

FLOT is a fund comprised of bonds that adjust their interest rates in real-time in response to rising interest rates. As a result you don’t need to worry as much about fixed interest rates. 

FLOT allows you to incorporate floating rate bonds issued to corporations like Goldman Sachs. This approach could enable you to benefit as rates increase across consumer-focused loans, such as credit card plans and variable rate mortgages. 

Some other ETFs that are worth looking into include:

• SPDR S&P Regional Banking ETF (KRE)
• WisdomTree Interest Rate Hedged U.S. Aggregate Bond Fund (AGZD)
• Simplify Interest Rate Hedge ETF (PFIX)