How Inflation is Affecting Your Portfolio Right Now
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Inflation affects your portfolio right here, right now. You probably already know about the dark side of inflation and how it affects your portfolio (that's why you invest heavily in stocks, right?), but have you really taken the steps to combat it? Let's find out.
What is Inflation?
Inflation measures the rising cost of goods and services in a society. The gradual rise in prices results in a slow motion decline of how much you can purchase with $1 over time.
Inflation might not seem like it makes a difference from one year to the next. However, over many years and decades, it can really make a difference how much (or how little) you can actually purchase with your money.
How You Know Inflation is at Work
Some level of inflation is normal, as long as it's around 2%, and some even signals that the economy is healthy.
- Utility stock prices: Typically pretty stable in share prices and dividends, utility stocks that experience a long-term sell-off can result in an upward tick in inflation.
- Raw material prices: When lumber rises, beware. An increase in raw material commodities can signal the bellwether for inflation.
- Metals: You've probably heard that people often use gold and silver as an inflation hedge. Gold typically rises when the dollar falls, but a rise in gold prices can indicate inflation.
- Wages: Wage push inflation happens when wages increase and businesses must charge more for their products and services to pay for those wages.
How Inflation is Affecting Your Savings Right Now
Got money stashed in a money market fund? In a savings account? You know what's happening to it as you read this, right? It's shrinking.
When you've secured funds in a savings account (even a high-yield savings account), inflation kicks down the (very small) amount of money you're earning in interest. Unfortunately, many savings accounts offer little to no interest and can make your cash worth even less.
That's why it's important to check your emergency savings and determine whether you have too much in the account. If you have more than three to six months' worth of emergency fund money in your account, swipe some of that money into a different type of account that bears more interest.
How Inflation is Affecting Your Fixed Income Investments Right Now
You may have a few fixed-income securities sprinkled throughout your portfolio. Fixed income investments include bonds, treasuries and CDs which offer a stable income stream. However, the interest rate doesn't change on most fixed-income securities, so the purchasing power of these types of investments declines as inflation rises.
How Inflation is Affecting Your Stocks Right Now
Stocks generally hold up well against inflation because (hopefully) a company’s revenues and earnings increase at a similar pace as inflation. This means stock prices should rise as the prices of consumer and producer goods also go up. Stocks can provide a decent hedge against inflation, because they can generate returns in excess of inflation.
However, rising inflation means consumers purchase fewer goods and services, so companies' profits go down and affect stock prices. Value stocks perform better during high inflation periods and growth stocks perform better during low inflation.
If you want to invest in long-term assets, invest in a broadly diversified portfolio of low-cost stock index funds. You can pluck your 401(k) or IRA up and invest in a target-date fund or another type of stock index fund.
How Inflation is Affecting Your Real Assets Right Now
Guess what. Assets like commodities and real estate usually work well with inflation. Energy-related commodities like oil, industrial and precious metals usually rise when inflation goes up! For example, rising prices for rental property rates can help you if you're a landlord.
However, real assets tend to have more volatility than other asset classes and often underperform stocks and bonds over long-term investing timelines.
How to Get Ahead of Inflation
If you take a look at your overall profile, you may realize that you need to switch up your portfolio to act as an inflation hedge. Check out a few ways you can do this:
- Use real estate as a hedge. Property values rise when inflation starts to heat up, and you can therefore charge more for rent. You'll earn a higher rental income over time and keep pace with inflation.
- Invest in TIPS. Treasury Inflation-Protected Securities (TIPS), are designed to protect you against inflation. TIPS principal increases with inflation and decreases with deflation, and it's all based on the Consumer Price Index. You get paid the adjusted principal or original principal when the TIPS mature, whichever is higher.
- Choose equity investments. Many experts look to equities as a great way to couch your portfolio against the downsides of inflation. Corporate earnings usually grow faster during high periods of inflation because people spend more money and the economy grows.
- Invest in commodities. Commodity prices usually rise when inflation goes up, so investing in commodities may help guard against inflation. Think natural gas and grains, crude oil and metals.
- Choose to invest in REITs. Naturally, real estate investment trusts (REITs) serve as an inflation hedge because real estate does the same during periods of inflation. REITs are companies that own and often operate income-producing real estate, which can include office and apartment buildings, warehouses, hospitals, shopping centers, hotels and more. When real estate rents and values increase, dividend growth increases and can offer an income stream for investors, even during inflation.
Get Inflation Proof
Ready to get an exterior shell-like steel against inflation? Learn about your current investments and how sturdy they are against the inevitability of inflation. Luckily, you can do a few things to combat it, but don't let inaction become your enemy. Take action against inflation and you'll insulate yourself (more or less) from it and build for the future.
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