The new year has come with a growing challenge for investors: inflation. Driven by supply chain problems and labor shortages, prices on many important consumer goods have begun to soar. In December, the annual rise in the consumer price index hit 7%—the highest rate since 1981!
Inflationary periods are a bad time for savers, but they can be good for borrowers and investors. You may need to change your investment strategies a bit to make the best of the current economic climate.
What Is Happening?
Low interest rates from the Federal Reserve and high energy costs are driving much of the inflation of the past year. Economists hope the rates will calm down soon, but it may take a few months. In the hopes of slowing it down, the Federal Reserve hopes to gradually raise rates over the course of 2022.
Experts predict that as supply chains recover, many of the price increases we saw in 2021 won’t last, or at least won’t get worse. Rents, however, may continue to increase. So will labor costs.
There are too many variables to be sure of the future. More coronavirus variants, if they emerge, will certainly cause more chaos. And supply chains can get tangled again. But most experts hope inflation will peak and decline soon.
Cash Loses Value
Any time inflation is happening, the cash in your wallet loses value. That means any money you keep in cash isn’t just failing to increase—it’s slowly disappearing. That’s generally true of savings accounts as well. The interest on them simply doesn’t keep pace with inflation.
Keep only a small emergency fund in cash. Everything else can be invested. For funds you need to keep relatively liquid, a shorter-term CD or money market account can be a good option.
Inflation’s Effect on Bonds
When inflation rises, interest rates rise as well. That means that newly-issued bonds will be worth more than any bonds you hold today. So, in general, a time of inflation, with interest rates set to rise, can be a bad time to buy new bonds, or to sell bonds you’re currently holding.
In addition, since bond interest rates are low, they don’t always keep up with inflation. You end up with the same problem you have with cash—most of the value of your investment is lost to inflation.
One solution is Treasury Inflation-Protected Securities (TIPS)—a type of bond designed to keep up with inflation. Or there’s floating-rate bonds, which change their interest rates over time. This means they will rise along with inflation. Another option is to stick to short-term bonds. These shouldn’t lose much value in the time you keep them.
How to Invest in a High-Inflation Market
So what instruments do keep pace with inflation? Stocks tend to do well, and mutual funds that contain stocks. While stocks rise in an expanding economy like this one, remember to keep your portfolio diverse. No individual stock is guaranteed to succeed.
Real estate and commodities also keep pace with inflation. There are lots of ways to invest. If you’re not interested in keeping rental properties or flipping houses, real estate investment trusts (REITs) are a possibility. For commodities, you might consider exchange-traded funds (ETFs) in commodities, or stock in companies that produce those commodities.
Some investors turn to gold, art, or cryptocurrency. While these investments do tend to offer some protection against inflation, they’re not the guaranteed solution many assume. Gold fluctuates some in the short term, so it isn’t the perfect vehicle for a short-term inflationary period like we’re experiencing now. And cryptocurrency has taken a bit of a hit recently, so it’s an even less certain investment.
Your Advisor Can Help
Articles like this one offering investment tips are useful, but they can’t replace a financial advisor. No online stranger knows your situation or has a fiduciary duty to you. Ask your advisor what parts of your investment portfolio are vulnerable to inflation and how to shore them up. If you don’t yet have a financial advisor, we can set you up with the right one for you. Contact us today!
