Inflation occurs when goods and services become more expensive over a set period. In other words, your money doesn’t buy as much as it used to.
Some inflation is normal. The average for the last century is between 2-3% per year. However, sometimes inflation is much higher. For example, in 2022, it was 8.3%.
High inflation impacts investment portfolios, retirement accounts, and consumers’ purchasing power. Your investments need to grow as fast as inflation to retain their value and outpace it to increase in value. Over the past 15 years, the main U.S. stock index, the S&P 500, grew by 13.8%. Even with inflation over that period, it gained 11.2%. However, investments with a yield of less than 8.3% would have lost value in 2022.
Low-yield investments are often safe, but they can lose significant value during periods of high inflation. As an investor, you need to take steps to ensure your portfolio outpaces inflation and hedge against periods of high inflation.
Diversification as a Key Strategy During Inflation
Diversification is the primary tool investors have to protect themselves against economic downturns, inflation, and other potentially damaging events. The process involves balancing your portfolio between different asset classes and industries.
For example, precious metals like gold often retain value better during high inflation and bear markets. There are also other assets, like inflation-protected securities, that can help reduce the damage inflation does to your portfolio.
Real Assets and Their Role in Protecting Against Inflation
Real assets like property and commodities, also respond well to inflation. In addition to physical assets, you can invest in securities that represent real assets. For instance, you can purchase securities for utility companies or buy bonds that fund infrastructure projects. Real estate investment trusts (REITs) are another option for tradable securities that track physical assets.
The Importance of Liquid Assets in Times of Inflation
Liquid assets are cash or investments that you could quickly turn into cash by selling. Liquidity is important because it allows you to adjust immediately if you face new investing challenges. For instance, during periods of inflation, you may want to sell certain stocks and purchase other securities that are more resistant to inflation.
The problem is that less liquid investments, like real assets, often offer a better return on investment. One strategy is to use these investments as collateral to get cash, increasing your liquidity without selling your holdings.
This gives you more flexibility to respond to financial challenges or cover the increased costs of purchasing necessities or operating your business during high inflation periods.
Managing Liquidity With Stock Loans
Stock loans are one way to increase liquidity. Stocks are not as liquid as cash-based assets like money market accounts, but they are more liquid than real estate.
While you can turn stocks into cash by selling them, you can use a stock loan to access cash without selling your securities. You use your stock as collateral for the loan, locking in a low interest rate compared to an unsecured loan. You can get a stock loan estimate to check rates and repayment terms.
Over the long term, the stock market should continue to rise, as it has done for most of the past century. Retaining a well-balanced portfolio allows you to take advantage of this growth. However, in the short term, you can leverage the value of your portfolio to have more cash on hand to deal with the effects of inflation or to add inflation-proof assets to your portfolio.
Utilizing Fixed Income Investments Wisely
Fixed income assets pay a pre-specified amount of interest during regular periods or at expiration. These investments include savings accounts, certificates of deposit (CDs), and bonds. Though they offer guaranteed returns, these assets are problematic during high inflation.
If inflation is higher than the interest payments, bonds and CDs will fall in value. Since they have a fixed lifespan, they could expire during the inflation period, leaving you with less value than when you purchased them.
One option is a Treasury Inflation-Protected Security (TIPS), which is a treasury bond with interest payments adjusted for inflation. These investments will keep pace with inflation, preserving your investment.
The Impact of Inflation on Stock Market Investments
Over the long term, the stock market grows faster than inflation. In the short term, however, inflation can outpace the growth of some stocks.
Securities that track real assets, like REITs, utility stocks, and precious metal ETFs, often perform well during high inflation periods. You can diversify your portfolio and prepare for inflation by adding these stocks and funds to your holdings. Then, if needed, you can use available cash to purchase more real asset stocks during high inflation.
Foreign Investments as an Inflation Hedge
You can also consider looking for overseas investments. While inflation can cross borders, it may not be as bad in some countries as it is in others. While you can invest directly in other countries, you can also purchase exchange-traded funds (ETFs) that track foreign economies or purchase foreign currencies on forex exchanges.
When investing in foreign markets, you need to be aware of forex risks. Currency fluctuations can affect the value of foreign stocks or funds. Even if the securities increase in value, changing exchange rates could lead to losses when you transfer the profits back to the U.S. dollar.
The Role of Cryptocurrency in an Inflationary Economy
Some investors look to cryptocurrencies as a way to avoid the impact of inflation. Though more volatile than traditional safe havens like gold, cryptocurrencies usually increase in value when major economies like the U.S. experience inflation.
However, you should keep in mind that cryptocurrencies such as Bitcoin and its peers are sometimes subject to uncertainty due to factors like increased regulation, cybersecurity concerns, or the closing of major cryptocurrency exchanges. You need to understand these factors before investing in digital currencies.
Monitoring and Adjusting Your Investment Strategy
You need to rebalance your portfolio from time to time. Some investments may no longer offer the profits you seek, and others may not suit the current inflation trends. You should review your portfolio regularly, and ensure it has the proper balance of assets and sufficient diversification.
You also need to keep up with economic and market trends, which can help you be aware of the potential for major events, like market crashes or recessions.
Inflation presents challenges to investors. However, increased liquidity and a well-balanced portfolio with inflation-proof assets can help you continue to grow your wealth despite decreasing purchasing power.
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