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Research shows that one of the best ways to inflation-proof your investments is with commodities. The only problem is that commodity futures contracts have zero dividend yield and can be difficult to trade.
In a study titled “The Best Strategies for Inflationary Times,” researchers found that both stocks and bonds perform poorly during inflationary times.
The annualized real return of U.S. stocks (after adjusting for inflation) averaged minus-7% during eight inflationary periods since World War II.
The one major asset class that does reliably outperform when inflation is running hot, as it is right now, is commodities with real returns averaging a whopping 14% per year!
As you can see in the chart above, real assets such as commodities, energy, and real estate beat inflation during the 1970s. They also outperformed the stock market by a wide margin.
But as mentioned earlier, investing directly in commodities is not an easy game for most investors.
For one, you’ll need a commodity futures trading account, which is generally not offered by most brokers.
Second, larger margin trading requirements for futures means that you’ll most likely need a sizeable account to get started.
Third, the leverage involved means you can earn large gains if you’re right, but it also means you’ll take big losses if your trade timing is off.
As an alternative, there are ETFs that track commodities, but most don’t do a very good job of delivering on the upside.
Commodity ETFs suffer from what’s called “negative roll yield,” which is a fancy Wall Street phrase that means you don’t always get what you pay for.
For instance, ETFs that track commodities like oil must continuously roll their futures contracts from one month to the next. But most of the time, next month’s oil futures contract is priced higher than the current month’s contract is worth.
That means an oil-tracking ETF loses value every time it rolls its oil futures contracts. And after several months, the oil ETF’s performance doesn’t live up to the actual gains from crude oil itself.
So, what’s an investor to do?
Is there a reliable way to earn inflation-proof gains without the hassle of buying commodities?
In my book, the easiest and most economical way to invest in commodities is through buying high-quality, dividend-paying stocks that produce commodities.
An added advantage is that commodity stocks often outperform the commodity itself, thanks in large part to the rich dividend yields they can offer investors.
For instance, everyone knows energy prices have been through the roof this year. But crude oil is up less than 2% since early March.
Meanwhile, the SPDR S&P Energy Sector ETF (XLE), which tracks large energy-producing stocks, is up more than 7% over the same time period. That’s nearly four times more upside from oil stocks than from the price of oil itself.
Plus, the energy sector stocks that make up XLE pay you a generous dividend yield of 3% on average while you wait for more price gains from energy stocks.
And many of the top stocks in this ETF pay even more.
- Exxon Mobile (XOM) offers you an 3.9% dividend yield.
- Chevron Corp. (CVX) pay a 3.2% annual dividend.
- Devon Energy (DVN) pays out a fat 6.3% dividend yield!