A picture representing the recent inflation in U.S. currency.
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Inflation is a major consideration when it comes to the performance of investment portfolios. Due to a convergence of different economic factors including scarcity of workers, pent-up demand and insufficient supply, inflation recently hit a 30-year-high.
The fear of inflation is not unmerited, as it can be challenging for investors and consumers alike to navigate a high-inflation market. However, diligent investors must focus their efforts on managing the risk to their portfolios to the best of their ability. By understanding the impact of inflation on stocks and bonds, as well as what sectors to watch and avoid, investors can proactively hedge against the impacts of inflation.
Inflation’s Impact on Stocks and Bonds
To best understand how to proactively manage a portfolio through high inflation, it’s key to understand the impact that it has on stocks and bonds.
Bonds are traditionally stable, low-risk and good hedges from the potential volatility of stocks. Unfortunately, the bond market does not do well with inflation. When inflation rises, the Federal Reserve will increase interest rates to decrease borrowing, driving the value of the dollar down even as the cost of goods rises and spending power drops. This causes bond yields (interest) to increase as investors demand compensation for inflation risk. Ultimately, the price of the bonds will drop as investors lose interest in it, lowering the value of your investment.
While this is not promising for the bond market, investors can look towards TIPS (Treasury Inflation-Protected Securities) bonds, which adjust the bond’s principal value based on inflation. Further, placing emphasis on other investments during this period is important.
While stocks are generally more volatile than bonds, they will more likely keep up with inflation. Because the market tends to be cyclical, diversified portfolios are usually equipped to handle inflation concerns. Many financial experts discourage rebalancing the portfolio during inflation, as long as one is already sufficiently diversified.
High inflation certainly puts a damper on bonds and stock returns. Don’t rush into a complete portfolio overhaul out of fear. Instead, diversify and rebalance your investments with slight overweighs to enhance portfolio performance.
Sectors To Watch
There are definitive sectors that are more likely to better manage inflationary risks, including tangible assets, commodities and inflation-protected bonds. Outside these sectors, a well-balanced portfolio is another good hedge.
Tangible assets focus mostly on real estate and real estate investment trusts. Inflation is beneficial to real estate investors for a few reasons: it acts as a discount to debt (increases equity), it increases rental income for investment …….