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Markets and economy

How to hedge against inflation in your portfolio

Educate investors on the risks of holding cash investments and the benefits of ETFs.
5 minute read
May 31, 2022
Markets and economy
Market volatility

At a glance

  • Why playing it safe in your portfolio may be a huge risk.
  • Understand the importance of maintaining a balanced portfolio.
  • Explore our ETF (exchange-traded fund) options as a way to meet your goals.

Many investors consider cash investments to be a safe investing decision. But with inflation on the rise, cash investments may actually introduce a different type of risk to your portfolio.

What’s the risk of holding too much cash?

Cash investments refer to money market funds, savings accounts, or CDs (certificates of deposit). They generally provide a modest amount of interest while still remaining relatively safe. We recommend holding enough cash to cover 3–6 months of living expenses and possible emergencies, but after that, holding cash can do more harm than good.

Inflation—which refers to how things become more expensive over time—has been steadily rising, which means your money could be losing its purchasing power. Having too much cash in your account increases your shortfall risk—the risk that you won’t meet your goals due to low returns from your cash investments. The only way to keep up with inflation is to hold your cash in investments that have the opportunity to go up more than inflation will.

What does a balanced portfolio look like?

Our investment philosophy focuses on factors that you can control: balance, costs, discipline, and goals. Your asset allocation should be a balance of stocks, bonds, and other investments that reflect your goals and the amount of risk you can take on. As time goes on and the market ebbs and flows, it’s important to stay disciplined and not make decisions based off emotions. Remaining clear-headed and focused on the long term is the best way to achieve investing success.

How can ETFs help you achieve your goals?

With our investing principles in mind, consider investing in ETFs as a way to diversify your portfolio and hedge against inflation risk. An ETF is a collection of hundreds or thousands of stocks and bonds that trade on one of the major exchanges. They’re built the same as mutual funds, but typically have lower expense ratios. The more you save, the more you can invest in your future.

Let’s explore two categories of ETFs that can achieve different goals:

Short-term bond ETFs can help offset inflation

If you’d like to invest in a product that can offer more than a money market fund without a lot of risk, look to short-term bond ETFs. Their share price will fluctuate, but they generally aren’t as risky as equities.

Vanguard Ultra-Short Bond ETF (VUSB) is an active ETF that’s suitable for a time horizon of 6 to 18 months and aims to maintain limited price volatility. Since it’s actively managed, there’s potential for outperformance. This ETF is designed to offer slightly higher yields than money market funds while maintaining limited price volatility.

Vanguard Short-Term Bond ETF (BSV) is an index ETF that invests in U.S. government and high-quality (investment-grade) corporate bonds. It’s most appropriate for investors with a time horizon of 1.5 to 3 years. This ETF can offer slightly higher returns than VUSB, but with a little more risk involved.

Total market ETFs can balance your portfolio

Want broad diversification? The following index ETFs have a combined 28,000+ holdings* and offer a simple way to diversify your portfolio. We recommend you use all 4 of these for a diversified portfolio. While they’re riskier than the short-term bond ETFs, they also offer the opportunity for higher reward.

Vanguard Total Bond Market ETF (BND) invests in the U.S. bond market and offers the potential for a reliable stream of income. This ETF is appropriate for medium or long-term time horizons and can offset some of the volatility that comes with owning equities.

Vanguard Total International Bond ETF (BNDX) provides exposure to major bond markets outside the United States. BNDX also uses currency hedging, which means investors can benefit from the diversification that international bonds provide without the extra volatility associated with foreign exchange rates.

Vanguard Total Stock Market ETF (VTI) is designed to track the performance of the entire investable U.S. stock market. Stocks focus primarily on growth and are historically the best asset class at outpacing inflation. While this fund can offer higher returns, it ranks higher on the risk scale and is considered suitable for investors with longer time horizons.

Vanguard Total International Stock ETF (VXUS) offers broad exposure to equity markets outside the U.S. and is appropriate for investors whose main objective is growth. Exposure to international markets can provide even more diversification in your portfolio.

Need help deciding what to do? Take our investor questionnaire to gain a better understanding of which funds are most suitable for your goals.

As an investor at Vanguard, you’re also an owner, which means we always put your best interests first. We want you to know that sometimes playing it too safe can be a risk, and we have other options available to help you to meet your goals. And as always, building a strong, diversified portfolio is key to long-term investment success.

Explore our ETFs and how they can diversify your portfolio

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*Source: Vanguard, as of April 30, 2022.

For more information about Vanguard mutual funds and ETFs, visit Vanguard mutual fund prospectuses or Vanguard ETF prospectuses to obtain a prospectus or, if available, a summary prospectus. Investment objectives, risks, charges, expenses, and other important information are contained in the prospectus; read and consider it carefully before investing.

All investing is subject to risk, including the possible loss of the money you invest. Diversification does not ensure a profit or protect against a loss.

Vanguard is investor-owned, meaning the fund shareholders own the funds, which in turn own Vanguard.

Vanguard ETF Shares are not redeemable with the issuing Fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market and hold those shares in a brokerage account. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.

Bond funds are subject to interest rate risk, which is the chance bond prices overall will decline because of rising interest rates, and credit risk, which is the chance a bond issuer will fail to pay interest and principal in a timely manner or that negative perceptions of the issuer’s ability to make such payments will cause the price of that bond to decline.

Investments in stocks or bonds issued by non-U.S. companies are subject to risks including country/regional risk, which is the chance that political upheaval, financial troubles, or natural disasters will adversely affect the value of securities issued by companies in foreign countries or regions; and currency risk, which is the chance that the value of a foreign investment, measured in U.S. dollars, will decrease because of unfavorable changes in currency exchange rates.