Inflation has an enormous influence on how investment resources are allocated and determines savers’ decisions about where and how to place their savings, whether it’s physical assets or financial.
Investors looking to protect themselves against inflation should diversify their portfolio with assets like shares and real estate that possess pricing power, in order to create a broad and diversified basket.
High inflation usually causes bond prices to decline because it reduces their real rate of return, as well as increasing interest rates which further diminish bond returns. Furthermore, inflation can sometimes cause interest rates to spike which further erode returns on bonds.
Real estate and commodities tend to perform well during times of inflation, acting as diversifiers within portfolios and helping protect against the risk associated with stocks.
Numerous investment products provide protection from inflation. Treasury inflation-protected securities (TIPS) increase their payments in line with inflation rates; mutual and exchange-traded funds that invest in commodities like oil, grains and precious metals which tend to appreciate alongside inflation; as well as global multi-asset portfolios with appropriate allocations can offer some measure of protection and diversification potential; the key here being not overstuffing bonds which tend to perform less during inflationary times.
What stocks perform well in inflationary environments depends heavily on the company in question. Companies producing essential consumer goods usually do better as they can pass along higher costs to customers without impacting profits as much. Utility stocks are an excellent example, since they can raise prices while still maintaining profits; staple goods manufacturers may also see increases in demand as explained by economic principles such as supply and demand.
Value stocks generally outperform growth stocks in inflationary environments. Investors should look for funds with dividends tied to inflation rates or invest in infrastructure assets which generate revenues tied to inflationary benchmarks.
If you watch or read financial articles, experts and economists often discuss inflation. While most discussions centre around how higher grocery store prices erode purchasing power, inflation also has significant ramifications for savings and investments plans.
For instance, if you keep your savings in cash or low-interest savings accounts, inflation can rapidly reduce their value over time. Even if your bank offers higher-than-average interest rates, they may not be sufficient to keep pace with inflation.
Conversely, investing alongside inflation could help preserve your purchasing power; however, too-rapid inflation can depress economic growth and companies may struggle to pass along price increases to customers. When this occurs, investors may wish to adjust their portfolio allocations and assess their risks, returns, and diversification potential in light of this reality.
Inflation can increase prices for certain goods and services, helping businesses protect their profit margins. Home builders, for instance, can raise home costs to meet rising buyer demand.
Rising prices allow firms to charge higher wages, directly benefitting workers. A little inflation is good for consumers; however, unchecked inflation could damage the economy significantly.
An optimal portfolio for investors should include investments across all the major asset classes. Bonds tend to be vulnerable to inflation as their payments are fixed rates; when prices increase, so does purchasing power decrease for these bonds. By contrast, stocks and real estate tend to outpace inflation rates over time, providing some degree of inflation protection.