Worried About Inflation? These 3 ETFs Offer Real Protection

Key Points

• Inflation is one of the key concerns for many investors worried about their wealth losing purchasing power over time.
• A group of ETFs, including TIP, DBC, and BIL, offers protection against inflation and may also generate attractive passive income through distributions.
• These funds make use of strategies involving TIPS, commodities, or T-Bills to keep pace with inflation.

Though inflation has improved, it remains one of the most significant threats to an investor's accumulation of wealth. Combined with stock market volatility and broader economic uncertainty, and investors find themselves in a risky environment. To protect against inflation, consider devoting a portion of your portfolio to assets specifically designed as a hedge. These can include tangible assets like real estate as well as commodities, precious metals, and so on.

Investors may overlook bonds, though they are an important part of this list of inflation-hedging vehicles as well. One of the easiest and most effective ways of building exposure to bonds is with the help of an exchange-traded fund (ETF). ETFs make the bond purchasing process incredibly easy and have an added bonus of providing built-in diversification as well. Though they do carry annual fees, these are often low enough that they do not diminish a fund's value proposition or inflation hedging potential. The three inflation-blocking ETFs below may be a good place to start.

ETF Access to TIPS For Low-Risk Inflation Protection

For assets that provide inflation protection, one of the best options is TIPS, or Treasury Inflation-Protected Securities. These specialized bonds have been around for nearly three decades and have amassed a following of investors looking to guard against the erosive power of inflation. As inflation increases—as measured by the Consumer Price Index (CPI)—TIPS adjust their principal value upward and also pay out more in interest in order to keep pace with this rise.

The iShares TIPS Bond ETF NYSEARCA: TIP is among the largest TIPS-focused funds available to investors, with about $15 billion in invested assets. It is also one of the most liquid and has a one-month average trading volume above 3 million. Despite this liquidity, many investors will want to hold on to TIPS (or an ETF that holds a basket of them) for a long time in order to maximize their capacity to guard against inflation.

TIPS are considered very low-risk assets, and as such have minimal growth potential. Investors will benefit mostly from the distributions this ETF makes, rather than by price appreciation; it has a dividend yield of 3.13%, making it an attractive source of passive income given its expense ratio of 0.18%.

Multi-Commodities Fund Gives Access to More Than a Dozen Commodities Futures

The Invesco DB Commodity Index Tracking Fund NYSEARCA: DBC is a unique commodities ETF in that it tracks an index of more than a dozen different commodities futures. It is thus a go-to and convenient method for investors seeking broad exposure to the commodities space as a means of branching out from a traditional stocks-and-bonds portfolio.

Commodities are tangible materials that tend to provide a buffer against inflation. As the purchasing power of the dollar decreases with inflation, the price of these tangible goods may increase. Of course, DBC does not hold physical commodities, but rather invests in commodities futures for products such as oil, natural gas, gold, corn, and cattle. This makes the fund speculative and, depending upon the market conditions, somewhat volatile. It also has a fairly high total expense ratio of 0.89%, so investors should expect to pay a bit for this all-access exposure.

Ultrashort T-Bill Fund Guards Against Inflation and Volatility

With close to $44 billion in managed assets, the SPDR Bloomberg 1-3 Month T-Bill ETF NYSEARCA: BIL is a popular choice among investors looking to guard against inflation. As the name suggests, BIL offers exposure to U.S. Treasury Bills (T-Bills) that have remaining maturities between one and three months. By limiting its holdings to T-Bills with a short duration, BIL can help control for the risk associated with shifting interest rates; these rates are less likely to change over a 1-3 month period than over a longer duration.

BIL tracks an index of all investment-grade, fixed-rate, U.S.-dollar-denominated T-Bills in this duration window. By keeping risk extremely low, BIL acts as a compelling safe haven during periods of near-term market volatility. On the other hand, investors should not expect it to deliver on returns as a result. The appeal of BIL lies in its distributions; the fund pays a dividend yield of 4.19%, which is quite strong given its expense ratio of 0.14%.