If inflation stays higher, what may it mean for returns?

After years of low inflation, the environment investors have grown used to is starting to shift.

For most of the past two decades, inflation was low enough that many investors didn’t need to think about it. But that backdrop may now be shifting.

Treasury modelling flagged this month that the Iran conflict could push inflation to 5% or above. Both the RBA and the Federal Reserve have revised their inflation forecasts higher this year, with the RBA now expecting inflation to remain above its 2-3% target until early 2027.

The question isn’t how long this spike lasts – no one knows that for sure. It’s whether your long-term plan is built for a world where inflation runs higher than it has for most of the past two decades.

The part of investing that doesn’t show up on your statement

Inflation doesn’t register as a loss. It erodes what your money can buy over time, and it compounds in the same way returns do – except in the wrong direction.

Your real return is what you earn after inflation. For example, a portfolio growing at 6% a year sounds strong on paper. At 2.5% inflation, the real return is 3.5%. At 4% inflation, it falls to 2%.¹ That difference, sustained over time, can materially change the wealth you end up with, even after taxes and fees.

A higher assumed rate of inflation may also move the goalposts on your FIRE number retirement target. That nominal $1 million figure would now be $1 million plus the rate of inflation meaning the number you need to reach keeps rising, which means the return your portfolio needs to deliver rises with it.

The response to that isn’t panic – it’s preparation.

Three areas worth considering

For younger investors, time is still the most powerful tool available; markets recover and compounding works in your favour the longer you stay invested. Some investors adopt dollar-cost averaging into a growth-oriented managed portfolio like the Betashares Direct High Growth portfolio or the All Growth portfolio. More information on both portfolios can be found on the Betashares Direct platform.

For investors looking to add inflation resilience to an existing portfolio, there are particular assets that may help.

There is historical evidence that gold has been able to preserve most of its purchasing power through inflationary periods when paper assets have struggled. The Betashares Gold Bullion Currency Hedged ETF (ASX: QAU) uses hedging to reduce the impact of AUD/USD movements (before fees and expenses), allowing returns to more closely reflect changes in the gold price in USD.²

Royalty companies are businesses that own royalty streams on commodities or other assets, collecting a percentage of revenue rather than bearing production costs. That structure may be less exposed to rising input costs, although performance will depend on commodity prices and other factors. The Betashares Global Royalties ETF (ASX: ROYL) offers access to a global basket of them – a less obvious inflation hedge, but one with income attached.

For investors near drawdown stage, it may be worth considering assets designed to help protect real returns against inflation, although outcomes may vary.

Listed infrastructure often have revenues that are linked (to varying degrees) to inflation through regulated pricing or contractual arrangements. However, the extent of this linkage and its impact on income may vary. The Betashares FTSE Global Infrastructure Shares Currency Hedged ETF (ASX: TOLL) provides diversified exposure across global listed infrastructure companies with these types of characteristics.³

Meanwhile, the Betashares Inflation-Protected U.S. Treasury Bond Currency Hedged ETF (ASX: UTIP) provides exposure to a portfolio of bonds issued by the US Treasury (hedged into AUD), whose face value and interest payments are adjusted for inflation, as measured by US CPI. TIPS provide protection from a high inflation environment by indexing both principal and coupon payments to the US CPI. As part of a broader portfolio, UTIP may provide defensive benefits during times of significant global economic weakness.

Finally, it’s worth noting that term deposit rates, while nominally attractive, may deliver a real after-tax return close to zero in a higher inflation environment.

A reason to review, not a reason to panic

The goal isn’t to predict exactly where inflation goes. It’s to hold a portfolio that doesn’t depend on any single outcome.

The case for a diversified portfolio remains widely recognised. A potential shift in the inflation regime may prompt investors to take a clear-eyed look at whether the assumptions built into their plan still hold.