Inflation Is a Different Beast for Entrepreneurs. Here's How to Protect Yourself.
The experts at Bernstein Private Wealth offer their insights for small business owners feeling the crunch.
Inflation has been one of the major stories of the year, ripping through a growing portion of the global economy. How can entrepreneurs and business owners protect themselves and their financial futures in times like these? Bernstein Private Wealth experts Chris Brigham, Matt Palazzolo and Adam Sansiveri explain.
Inflation's Impact on Entrepreneurs
Entrepreneurs face inflationary pressures in two major ways. One is similar to other people—the impact that inflation has on their investment portfolios and their future purchasing power. The second is unique—the impact that it has on their businesses.
What to do about inflation depends greatly on how sensitive to it you are. Inflation protection involves trade-offs that make lots of sense for some people and less sense for others. In general, your inflation exposure is a function of three variables—the proportion of your wealth in stocks versus bonds, when you plan to retire (or if you're already retired), and your desired spending level. More stocks, more years to retirement, and lower spending all reduce your inflation sensitivity.
Entrepreneurs, though, may have unusual portfolios compared to the general population. Namely, they may have a large portion of their net worth tied up in their business.
One consideration is the way in which you think about your wealth from your business. Do you focus primarily on the income it generates for you or do you think of it in terms of the capital value that it would be worth in a sale? That's often dependent on the maturity of your business and your age and financial plan.
Your Business vs. Stock Indices
Your ownership of your business is an equity stake, similar to investments in public stocks, which usually offer a fair degree of inflation protection. However, we think of public stock investments as diversified portfolios, while your financial position may be abnormally exposed to the fundamentals in your industry and its structure. One key question to ask is how much can you raise prices without sacrificing sales and therefore how inflation-sensitive is your business?
We can see the difference by considering how differently Coca-Cola and 3M fared at the beginning of this year. Coca-Cola increased its sales by 7% via price and mix shifts, while also managing to sell 11% higher volumes than it did a year earlier, adding up to 18% organic revenue growth. On the other hand, 3M tried to raise prices, but appears to have still lost sales volumes in the process.
Which of those outcomes is more like what your business would face? You can think about it based on growth trends in your industry and any advantages that make it difficult for competitors to take market share even when you raise prices. The answer affects how much inflation protection you should have in the rest of your portfolio.
Protecting Your Portfolio
What does that portfolio protection look like? Depending on your asset mix and the size and inflation sensitivity of your business, you have different ways to protect your portfolio from inflation. A critical point here is that inflation can be hard to predict, so we view inflation protection as akin to an insurance policy. These ideas aren't tactical—if you're inflation-sensitive, they should be in your long-term strategic asset allocation.
Generally, our most inflation-sensitive clients have large fixed-income portfolios. For them, the key is to include bonds with inflation protection in their portfolios. We usually do that either by including Treasury Inflation Protected Securities (TIPS) or inflation swaps, depending on their tax bracket.
Investors with more of their portfolios in equities who are still inflation-sensitive may want to replace a portion of their diversified stock holding with a mix of commodity futures and stocks in industries that have pricing power.
Accredited investors or qualified purchasers may find attractive inflation-protected opportunities in alternative asset classes such as private credit, real estate, and hedge funds.
Protecting Your Business
That's what you can do for your portfolio. What about your business?
Think carefully about the price/volume trade-off you face. Likewise, with employees looking for wage increases, figure out how much you're willing and able to give when it comes to raises. Are there other ways you can increase the recognition or happiness of your employees? For companies with rising raw materials costs, you may be able to reduce the volatility of your input costs by contracting with your suppliers in advance or by hedging raw material costs using commodity futures. The hope isn't that you make money on the hedge but rather that it allows you to better plan your business and smooth your cash flows.
Inflation is hard on everyone, including entrepreneurs and business owners. By coming at it in an informed way, with a strategic plan, you can weather the storm.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. Views are subject to change over time. Bernstein does not provide legal or tax advice.
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