Nurturing your investments has never been more important than what it is today. After the turbulence of the past few years, ensuring some stability and finding an adequate growth path is essential. One aspect that can play havoc with your investments is inflation. Read more here on how to navigate the inflation waters to best care for your investments.
If you’ve ever asked yourself “how does inflation affect my investments?” in this uncertain inflationary period, you’re certainly not alone. Americans across the country are wondering how current conditions might affect their holdings. Not all investments are equal. To assess inflation risks to your investments, you must first look at what kind of investments you're holding and determine their volatility.
Economics tell us that inflation directly governs purchasing power: as it goes up, currency strength goes down. On the other hand, as inflation decreases—also known as deflation—purchasing power increases. Experts make percentage estimates dictating the ebb and flow of purchasing power related to a particular set of goods. As the general price of that item increases, the currency unit associated with that item can't buy as much.
What exactly is the state of inflation in the US right now? Why does it matter to the world, to you, and to your investments?
What Does This Mean for Your Investments?
How does inflation affect investments? Unfortunately, there is no “simple” answer. Ultimately, the impact will depend on the nature of the asset.
When it comes to your assets, those with fixed, long-term cash flows generally perform poorly as inflation rises. The purchasing power of those future cash flows declines as inflation goes up. The bond market and other fixed-income investments are particularly susceptible, as cash earned upon maturity is less valuable during inflationary periods. Low-risk investors might prefer these markets as a source of stable income through fixed interest. However, as inflation increases, the purchasing power of that fixed-interest cash flow decreases. A maturing bond in 2017 had more purchasing power than the same bond—at the same rate—in 2022.
However, commodities and assets with adjustable cash flows generally perform well during inflationary periods. This includes income from property rentals, since landlords can always increase rent to offset inflation.
Stocks leverage basic principles to weather and even perform well during inflation. Rising prices often mean increased revenues; therefore, a company's stock value should also grow at a rate that parallels inflation. The relationship between stocks and inflation isn't necessarily airtight, but it's a relationship worth tracking nonetheless.
According to the most recent Forbes Advisor-Ipsos survey, Americans feel inflation's sting daily. The survey found that 25% of consumers are spending more than they're accustomed to. As to whether that’s likely to change anytime soon, forecasts look bleak. The Fed has moved away from its initial “transitory” position, pivoting to a new adjective: “entrenched.” Similarly, former Fed Chair and current Treasury Secretary Janet Yellen recently admitted she “was wrong [...] about the path that inflation would take.”
That doesn't mean the fight against inflation isn't active and ongoing. While the Fed won't likely achieve its target annual CPI range of 2%, projections have inflation falling to between 5% and 6% by the end of 2022.
Can You Hedge Against Inflation?
While the actual mechanics of inflation are out of your hands as an investor, there are certain moves you can make to hedge your portfolio against the rise. Understanding how inflation affects your investments is the first key to battling it. With that information in hand, you can move your money out of more volatile investment vehicles and into more inflation-friendly ones.
Shorten Maturities on Your Bonds
Take a look at reducing your exposure to long-duration bonds as they are the most sensitive to a rise in interest rates. While typically a lower yield, short-term bonds and floating rate debt instruments, are less sensitive to a rise in interest rates and can help preserve capital in an inflationary environment.
Treasury Inflation-Protected Securities, or TIPS, are government bonds that parallel inflation as it rises and falls. With TIP investments, as inflation goes up, so do paid interest rates. Subsequently, as inflation falls, so do the interest rates. TIPS can be beneficial as inflation fears persist.
Historically, stocks perform well during inflationary climates, especially if inflation is moderate, and companies are able to pass through rising costs to consumers. Stocks are riskier and come with greater volatility, but long-term investors can benefit from strong companies, that generate real profits, and have reasonable pricing power, even as inflation moves higher.
Consider Alternative Asset Classes
Real Estate - Property values tend to increase during inflationary periods. Therefore, real estate investments can perform well in these periods. Because landlords can increase rent to combat inflation, they can easily maintain profits and inflation-adjusted cash flow.
Commodities & Other Real Assets - Commodities and other real assets are different than stocks and bonds. As inflation rises, the price for oil, gas, corn, wheat, metals, and other real assets also tend to rise. A broad basket of commodities can help hedge inflation and provide overall diversification to a portfolio.
Hedged Assets – Inflation not only takes a bite out of purchasing power, it can also be the cause of lower investment returns generally. Absolute return and hedging strategies can be useful “risk-mitigating” tools when inflation is reducing the absolute level of investment returns across the majority of investment types.
Prepare Your Portfolio Against Inflation Today
Inflation is at an all-time high, so investors must do everything they can to safeguard their portfolios ASAP. Ultimately, inflation leaves its mark on all investment vehicles—some costly and some profitable. Thankfully, assets like TIPS, real estate, and stocks offer just a handful of ways you can hedge against inflation.
For more information as to how inflation might affect your investments, it helps to have a trusted financial partner like Wisconsin Bank & Trust by your side. Contact the team members at Wisconsin Bank & Trust today to learn more about these and other inflation-friendly investment vehicles.
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Wealth Advisory Services does not provide accounting, legal or tax advice. This information discusses general economic and market activity and is presented for informational purposes only and should not be construed as investment advice. Views and opinions expressed herein do not account for any specific investment objective, restrictions, and/or financial circumstances of any specific client. The views and strategies described may not be suitable for all investors. Investors are urged to consult with their financial advisors before buying or selling any securities.