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A Terrible Way To Protect A Retiree From Inflation

People seem to think commodities (especially gold) are suitable guards against inflation.

I want to explain why that’s not true – at least over any useful time frame – and then tell you about some of the much better tools available.

Commodities are just things. They don’t produce any value in and of themselves. They’re like a ceramic cat sitting on the shelf. Yes, they’re valuable, but they don’t create new economic activity. If the market is a pie, commodities are already baked in there and they are not going to make the pie any bigger.

This is fundamentally different than investing in a company. Companies are going concerns, meaning they create economic value (or at least try to). They have the capacity to increase the size of our market pie through expanding business, a good year, or other value-adding factors.

For more investing insights, check out Bob’s ebook “12 Principles of Intelligent Investors.”

Because commodities are just things, their long-term expected returns should basically match inflation. But what gets people excited about commodities (at least every couple of years or so) is their massive volatility.

That may seem counterintuitive – generally you don’t want to add any more volatility into your portfolio than you need to. That volatility means that every once in a while, commodities will have huge returns, and those huge returns will occasionally line up with poor returns in other asset classes.

But they also have some truly abysmal years to bring the long-term returns back down to Earth. This isn’t a very good recipe for something that moves as slowly and steadily as inflation.

Inflation and Commodity Data from 4/16-6/22

Annualized ReturnAnnualized Standard DeviationGrowth of $1
COMMODITIES(Bloomberg Commodity Total Return Index)3.14%14.75%$2.64
INFLATION(US Consumer Price Index)2.54%1.19%$2.20
STOCK MARKET(S&P 500 Index)9.61%14.45%$10.13

Data provided by Dimensional Fund Advisors. Indices are not available for direct investment. Past performance is not indicative of future returns.

Over a long-term period (roughly twenty-five years), Inflation and Commodities have roughly the same return, but look at the standard deviations. Commodities are bouncing around more than the S&P 500 Index. Investing in commodities adds a huge chunk of risk to your portfolio, but none of the payoff that you would get in the S&P 500.

It gets even worse if we zoom in on a specific commodity like gold or oil:

Inflation and Commodity Data from 4/16 – 6/22

Annualized ReturnAnnualized Standard DeviationGrowth of $1
GOLD(Gold Spot Price)-2.64%23.17%$0.77
OIL(Global Price of Oil)0.65%28.29%$1.27
STOCK MARKET(S&P 500 Index)11.47%15.13%$51.62
INFLATION(US Consumer Price Index)3.18%1.23%$3.12

Data for the S&P 500 Index and US Consumer Price Index provided by Dimensional Fund Advisors. Gold Spot Price and Oil returns computed from data provided by the Federal Reserve Bank of St. Louis.[1] Indices are not available for direct investment. Past performance is not indicative of future returns.

Gold and oil actually underperform inflation. If you had invested a dollar in either of those commodities, you would end up with less money than if you had just stuck that dollar in a money market fund. That’s not much of a hedge.

Commodities are even worse inflation hedges for retirees. As I said before, commodities bring in inflation-like returns over long periods, but think about what those standard deviation numbers mean in the short term. At any given time, you could be on the wrong end of inflation.

If you’re spending from your portfolio (as retirees often are), you are locking in those big ugly losses. Just look at oil’s 33% dive in 2015. Younger folks could choose to ride that out because their main income source is their salary, but the majority of retirees don’t have that luxury.

What Better Tools Are Available?

You definitely don’t want to let inflation steal your portfolio’s purchasing power, but commodities clearly aren’t the answer. So what should you try instead?

There are two main options:

  1. You can either directly hedge some of your inflation risk with TIPS, which are US Treasury securities that adjust based on what inflation has been doing, or
  2. You can go the indirect route by investing in securities that have higher expected returns than inflation.

Both options can work depending on your situation. Your advisor can help you figure out which option makes the most sense for you. As always, the important thing is that you stay disciplined, and stick with your financial plan.

To find out more about how to build an investment portfolio that works for you, read our eBook 9 Principles of Intelligent Investors.


[1] Returns computed from the monthly Global Price of WTI Crude. International Monetary Fund, Global price of WTI Crude©, retrieved from FRED, Federal Reserve Bank of St. Louis;, July 27,2022.

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