Yes and no. It depends on how well you’ve structured your financial life.
It seems like you can’t turn on the news without someone saying something about inflation these days. The price of everything is going up. From the milk you buy at the grocery store to the cost of lumber, consumers can’t seem to catch a break.
But is inflation really something you need to be worried about long-term?
As someone who doesn’t typically worry, per se, about the incremental costs of goods and services, you may be more concerned about how record inflation will affect your long-term investments.
The answer is that inflation does impact investments - short and long-term. Just how much and what you should do about it, if anything, is debatable. Let’s take a look at the potential impacts inflation can have on your investments and the steps you can take to keep your financial growth on an upward trajectory.
Historical Impact Inflation has on Investments
Inflation, defined by Investopedia as “the decline of purchasing power of a given currency over time,” is upon us.
According to the U.S. Labor Department, the inflation rate of the United States over a 12-month period ending in October 2021 is the highest it has been since November 1990 at 6.2%.
Image source: COINNEWS MEDIA GROUP, LLC
As you can observe in the simple chart above, we are not only experiencing record inflation but a steep and furious spike in inflation over a short period of time.
Inflation affects different classes of investments in different ways.
With the decline in purchasing power, this typically means that you may not be saving as much as the cost of goods and services outpaces your income. Usually, income keeps pace with inflation. However, in today’s economic environment, wages are not rising as quickly as inflation, which can reduce the amount you are able to save.
If you are retired and living off your retirement income, you care about inflation very much. The reason is that in a period of high inflation, your fixed income does not go as far, and you may spend down your retirement income more quickly than planned.
Interestingly, stocks have historically performed well during periods of temporary high inflation. The Wall Street Journal observes that after World War II, stocks did well in the 1950s due to pension funds buying equities for the first time. It is also because the economy itself grew and was able to keep up with rising prices.
Though, by the 1970s, stocks underperformed due to big government spending for the Vietnam War and other programs.
As a whole, stock prices have trended with inflation for the most part over the last 30 years, which is encouraging, but investors should be prepared for more volatility.
According to an analysis performed by the U.S. Bank Asset Management Group, real estate tends to have a positive relationship with inflation. This makes sense since it is a commodity, albeit a large one. As prices for goods and services increase, so too do the prices for real estate.
The same can hold true for other commodity investments like gold, agriculture, and oil and gas.
What Investors Can Do in a High Inflation Environment
As an investor, you may be wondering what some of the opportunities are right now. Or you may be wondering what types of investments you should hold back on until the current rate of inflation gets more under control.
Here are some ideas I share with my clients:
- Be careful of low-yield, long-duration bonds. Inflation typically causes interest rates to rise. Rising interest rates in long-duration bonds cause them to lose value. This article is good at explaining that correlation. Therefore, make sure your bond holdings remain “short duration” during these times. Also, look to TIPS (Treasury Inflation-Protected Securities) to pick up some additional protection in a rising interest rate environment. https://www.investopedia.com/articles/bonds/09/bond-market-interest-rates.asp
- Invest in asset classes that tend to perform well during inflationary periods. The following asset classes tend to perform well during inflationary periods, especially early in an inflationary period: Technology and consumer goods, real estate, and commodities such as gold and silver. Prices rise, and people initially have more money in their pockets, so the value of these securities tends to increase.
- Don’t hold onto consumer goods. Eventually, non-essential consumer spending will come to a halt, so be careful owning consumer goods for too long. Also, construction, materials, and financial companies usually struggle once concerns about slowing economic growth enter the marketplace.
Using factor tilting towards and away from these types of investments can help a portfolio perform better during all stages of the inflationary cycle. A trusted and experienced financial advisor typically does this on behalf of their clients.
What to Watch Out For as an Investor
As with any time, if you aren’t sure you are making the right moves with your investments, I encourage you to reach out to your financial advisor or start looking for one if you aren't currently working with someone.
The economy can cause people to make emotional investment decisions. You don’t want to do something reactive or drastic without knowing the long-term impact it may have on your total investment portfolio. Instead, tackle your investments objectively. Have a financial plan in place that anticipates inflationary periods like we’re in so that you don’t have to worry whether or not you’re still on track.