At AAII, we have long warned against market-timing strategies. The volatility incurred by the stock market demonstrates why.

As we show in this issue’s Dispatches, 2022 is the second-most volatile year since the financial crisis years of 2007–2009. Only 2020 saw more days when the S&P 500 index rose or fell by more than 2%. And this measure of daily volatility doesn’t account for the intraday swings that have occurred.

Attempting to time the direction of the market entails a large amount of behavioral risk. Even the professionals get it wrong, often. When volatility—both upward and downward price fluctuations—is high, crystal balls do more than just become cracked; they become cloudy and roll across dirty floors. Good luck trying to get a decent reading from one. (The Magic 8 Ball we have at the office might just be more accurate than the forecasts made by market commentators and others claiming to have foresight.)

Among the contributors to this year’s volatility is inflation. I don’t need to tell you it’s high; you experience the increase every time you buy something.

High inflation isn’t just a domestic problem, it’s a global problem. There are steps we investors can take to help protect our portfolios from inflation. Retirees can cap how much they take in portfolio withdrawals. Savers can increase the size of their contributions. (Both, obviously, are dependent on one’s financial flexibility.)

Investors can also add inflation fighters to their portfolios. Dividend-growing stocks and stocks with long-term capital appreciation potential—like small-cap value stocks—are two such options. Commodities have traditionally been a hedge against inflation, but getting exposure can be challenging because of differences in the strategies used by various commodity funds.

Two other options are Treasury inflation-protected securities (TIPS) and real estate investment trusts (REITs).

TIPS are government bonds whose principal (par value) adjusts to inflation. Though the coupon (interest rate) is fixed, the interest payments you receive from TIPS increase as the principal of the bond increases.

Think of it as a loan you make whose balance increases over time. You consistently get paid fixed interest but the larger the loan balance is, the larger the absolute size of those interest payments will be. You will receive more interest on a bond whose principal amount has been adjusted upward from $100,000 to $101,750.

AAII contributing editor Brian Haughey provides a more detailed explanation about how TIPS work, along with suggestions on when they may be more or less attractive than traditional bonds, in his article.

REITs are considered inflation fighters because not only do they own hard assets (land and property) but they also have the ability to increase revenue over time through both higher rents/leases and by selling property that has appreciated over time.

Dividends are another attraction for many investors. REITs are required to pay out at least 90% of their pretax income. This results in comparatively larger yields compared to most common stocks. (REIT distributions do not qualify for the lower dividend tax rate, however.)

The differentiated traits of REITs mean they must be analyzed differently than common stocks. Metrics such as net income and the price-earnings (P/E) ratio don’t work as well. Rather, funds from operations (FFO) and adjusted funds from operations (AFFO) should be looked at. Similarly, instead of the price-earnings ratio, price-to-FFO and price-to-AFFO multiples are used to value REITs. Analyst and investment newsletter writer Brad Thomas gives a primer on how to identify a blue-chip REIT in his article.

REITs, like other equities, are not immune from the swings in the stock market. The Vanguard Real Estate Index fund (VGSLX), which I personally own shares in, was down 29.3% year to date at the end of September. Over the long term, REITs have been shown to realize higher returns and to have lower correlations to large-cap stocks.

Finally, the paper market continues to be tight. Our printer said that paper mills will continue switching to corrugated paper if they can’t get good pricing on coated paper, which we use. Ink suppliers have been even more aggressive in raising costs.

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Wishing you prosperity, good health and a happy Thanksgiving,