After several rounds of stimulus checks and a year of supply chain disruptions, inflation was almost inevitable. People have money to spend, and manufacturers do not have the resources in place to keep up with demand.
The only recourse is to raise prices in the hope of slowing demand long enough to let the supply catch up. So, if you’ve noticed that you’re spending more to fill the gas tank or renovate the patio, you’re not imagining it. It has cost more.
The Consumer Price Index has been steadily increasing over the last few months, and June numbers showed a 5.4% increase. That’s the highest increase since 2008.
It’s also no surprise that inflation seems to be a big talking point at the moment. (It was even the topic of our March newsletter.) Everyone has tips for dealing with inflation and how to leverage your investments to avoid losses or make money in this economic environment. Unfortunately, that misses some of the concerns of most investors. Yes, protecting their investments is important, but they have deeper questions.
How Much Should I Worry About Inflation?
The signs indicate that we’re in an inflationary period, and the economic analysts and officials seem to think it’s transitory. Policymakers continue to believe that prices will revert to a trend when supply issues are resolved and manufacturers are able to catch up with demand. In many aspects, the current inflationary period is similar to the one seen immediately after World War II when the economy wrestled with war-related supply shortages.
That’s the good news. We’ve been in this situation before. In fact, inflation passed the 5% mark five more times since World War II. It happened from 1950 to 1951, 1969 to 1971, 1973 to 1982, 1989 to 1991, and in 2008. The prices of consumer goods, gas, and oil surged during these periods but then declined and leveled off. There’s plenty of reason to expect the same thing to happen in the coming months as manufacturers start increasing supply to ease demand.
If I Don’t Worry About Today, Should I Worry About Tomorrow?
For the next few months, you’ll notice a variety of messages urging you to take drastic steps like pulling all of your money out of the stock market, buying gold and cryptocurrency, or investing in real estate. Some of this advice sounds great on the surface. For example, assets like commodities and real estate tend to perform well during inflationary periods. Yet, they miss the bigger picture.
Here’s the thing. This type of advice can be short-sighted, especially in a transitory period of inflation. Over time, the stock market typically outperforms inflation. Investing your money in quality stocks and leaving it there may be better for your portfolio than panic trading. Cryptocurrency is so new that we still don’t know how it will fare over time. Trying to buy property at the moment may be impossible, depending on your local market conditions.
Protecting Your Portfolio
Inflation is part of the economic cycle, and it’s not inherently wrong. When prices go up, wages often follow — although some people may have to wait longer than others to see their paychecks increase. Sure, you pay more now for a loaf of bread than you would have 50 years ago, but chances are you’re also making more money now than you would have then. This is the difficult part of inflation – often, because of price increases, wages gains are off-set so there is no real increase.
The point is that you shouldn’t worry about inflation. Of course, inflation is real and it is a concern. But instead of worry, we suggest that investors should expect and prepare for it. What you will pay for a loaf of bread 25 years from now will likely be higher than what you pay today. If you’re retired by then, you may not be able to count on a higher paycheck to cover that cost. That’s why it’s so important to protect your portfolio and maximize gains over time, so you don’t lose too much purchasing power.
The Portfolio Balancing Act
As portfolio managers, one step that we can take now — and periodically until you retire — is to rebalance your portfolio. It allows us to evaluate your financial situation and the amount of risk we are comfortable taking at that time, because these things change over time! An inflationary market may be just the signal you need to look at your portfolio and adjust your allocations to better align with your financial goals.
Diversifying your portfolio across sectors and currencies can offer some protection against the forces of inflation in specific parts of the world. Although inflation can sometimes strike the global economy at the same time, it may not happen simultaneously. Even in the wake of the COVID-19 pandemic, some countries have had more success managing the virus than others, and their economies show it.
At the same time, some sectors of the economy perform better than others during inflationary periods, and you can take advantage of their gains. We’ve already mentioned commodities and real estate as traditional options for investors in inflationary markets. It may be that we begin to use more bonds and securities like Treasury Inflation-Protected Securities as a hedge against inflation.
However, specific investment decisions must be weighed against your long-term goals; therefore we prefer to take a planning-based approach to financial management. In this way we ‘manage in reality’ and adjust to changing conditions so that we align with your needs at every stage of life.
Investment Options During Inflationary Periods
All of the advice about investing during inflationary periods focuses on the types of investments that perform well under these economic conditions. There’s a reason some companies and sectors thrive when everyone else seems to panic. Let’s take a closer look at your investment options during inflationary periods and why they are recommended.
- Real Estate
One reason the housing market has been so hot across the country is the number of investors scooping up properties (of course Federal Reserve has had a hand, but we’ve written about that many times in the past). Yes, people were leaving cities in search of wide open spaces during the pandemic shutdowns, but they weren’t the only ones trying to get a deal. Investors know that real estate tends to hold its value during periods of inflation and typically goes up in value over time. As long as you buy property in a desirable location and hold on to it long enough, you’re less likely to lose your investment.
Real estate also provides an additional income stream if you rent out the properties. Single-family homes haven’t been the only properties in demand. Sales of multi-family homes also increased. Record-low mortgage rates and an increasing supply of renters in need of a place to live have made apartment buildings and duplexes popular among individual and institutional investors.
Like real estate, commodities usually perform well during inflationary periods because they remain in demand. People still need oil, gas, and food — and they’re willing to pay for it. So prices of commodities also increase with inflation. We saw this recently when the cost of lumber and steel increased earlier in 2021. The price increases were related to a combination of factors. The factories producing the materials shut down during the pandemic and needed time to get back to full capacity. As the housing market exploded, developers struggled to start building again. Without enough products in the supply chain, prices had nowhere to go but up.
The volatility of the stock market can be downright frightening, especially during inflationary periods. It’s enough to send some investors seeking a safer place to earn returns. The stock market has been on a steady climb higher for the past several years and while losses are natural it is scary. We actively manage and have tools which can be used to hedge against a falling market. We continue to invest in equity markets because of their long-term potential, but our bias will always be towards asset preservation.
Some stock values soar during inflationary periods. A team of analysts examined the performance of different stock sectors during periods of inflation. What they found was a “notable trend.” The S&P 500 performed well, as did utilities, construction and engineering, metals and mining, road and rail, consumable fuels, electrical equipment, and energy.
Sectors that didn’t perform as well included construction materials, retail, pharmaceuticals, food and beverage, and software.
The lesson? Life still goes on during inflationary periods. People still spend money. Businesses still make money. You can still invest in the stock market — just be aware of your allocations.
- Annuities and TIPS
If you absolutely have to move your money to safer places, annuities and bonds can be good options. An annuity with a guaranteed income rider gives you a predictable stream of income that may free up your other investment choices so you can take greater risks and potentially earn greater returns. These are not always appropriate and can often be misused. These investments can come with significant fees and surrender charges, though, and they should make up a modest portion of most portfolios.
Treasury Inflation-Protected Securities (TIPS) tend to be better choices than bonds for hedging against inflation. The U.S. Treasury backs these securities, and their interest rates fluctuate with the inflation rate, so you won’t lose too much money when rates go down. They are super safe investments, but they also won’t earn as much as other investment options.
Can You Sustain Your Lifestyle in Retirement?
Any discussion of inflationary periods and investments has to look at more than current events. Financial planning is a long-term game with serious consequences because people are living longer than ever before. Chances are good you will spend more years in retirement than your parents or grandparents. That means the money you have in your retirement funds has to stretch for more years. It’s also why it’s helpful to understand how economic cycles work, how inflation affects your finances, and how to plan accordingly.
Here’s why this matters: When you think about your retirement years, what do you envision? Do you plan to travel? Spend time with the grandkids? Explore new hobbies? You need money to do this! The trick is figuring out just how much money you need without knowing exactly what the economy will do between now and then. There are many factors and variables to consider as you make decisions today that affect your future. Watching the markets rise and fall can be dizzying, and you have better things to do with your time. As your advisor, we can keep track of the economy so you can focus on what’s important to you.
As we manage investments through this latest inflationary period, we will focus on making data driven, rational decisions. No one knows for sure what the economy will do in the coming months — but our job is to invest for the future instead of the moment. For now, we continue to monitor data and we are prepared to act if needed. Our team is here to assist you as you navigate the current economy. This is a great time to examine your financial goals and evaluate your risk tolerance. Then you’ll have the information you need to decide the best places to invest your money for now.
- The New York Times. (2021, July 17). Should you worry about inflation? Experts weigh in. The New York Times. https://www.nytimes.com/2021/07/17/business/dealbook/inflation-questions-experts.html.
- Rodosky, S. A., & Pagani, L. (n.d.). Positioning portfolios for a variety of inflation scenarios. Pacific Investment Management Company LLC. https://www.pimco.com/en-us/insights/blog/positioning-portfolios-for-a-variety-of-inflation-scenarios/.
- U.S. Bureau of Labor Statistics. (2021, July 13). Consumer price index summary. U.S. Bureau of Labor Statistics. https://www.bls.gov/news.release/cpi.nr0.htm.
- Kris Maksimovich, A. I. F. (2021, June 24). Should we be worried about inflation? Kiplinger. https://www.kiplinger.com/investing/economy/603015/should-we-be-worried-about-inflation.
- Powell, R. (2021, June 7). Worried about inflation? How to position your retirement accounts. MarketWatch. https://www.marketwatch.com/story/inflation-is-rising-how-to-reposition-your-retirement-accounts-11623075273.
- Watts, W. (2021, May 21). Inflation scare? The stocks that perform best – and worst – when prices rise. MarketWatch. https://www.marketwatch.com/story/inflation-scare-the-stocks-that-perform-best-and-worst-when-prices-rise-11621628256.
- Banton, C. (2021, June 26). Commodities: The portfolio hedge. Investopedia. https://www.investopedia.com/articles/trading/05/021605.asp.
- Ullman, M. (2020, August 28). How inflation affects your cost of living. Investopedia. https://www.investopedia.com/articles/personal-finance/081514/how-inflation-affects-your-cost-living.asp.
- U.S. News & World Report. (n.d.). Inflation has become a reality, so instead of worrying about what to do about it, here are 3 best investments to combat inflation. U.S. News & World Report. https://money.usnews.com/investing/investing-101/articles/best-investments-for-inflation.