I imagine that you are both tired of hearing about inflation, while simultaneously wanting to know what is going on and how best to navigate it.
The runaway inflation of the past year has definitely not been “transitory,” and is impacting many areas of our lives. If it feels like your dollar doesn’t go quite as far as it used to, you aren’t imagining it.
Inflation pertains to a gradual rise in prices, which sets in motion a slow decline in purchasing power. So whereas $5 might have bought you two venti mochas a decade ago, now it barely covers the cost of one.
As spending outpaces the production of goods and services, the supply of dollars in an economy exceeds the amount needed for financial transactions. The result is that the purchasing power of a dollar declines
On the positive side, you may benefit from wage inflation, but at the grocery store, gas station, and seemingly everywhere else, you’re experiencing higher prices.
Should You Worry About Inflation?
It is understandable that savers, spenders, and investors might all be concerned with inflation readings in the 8-9% range. In particular, if that level is sustained, how will households maintain their standard of living, and what kind of portfolio can generate returns that could keep up?
I won’t take a deep dive into the confluence of causes of the current high inflation, but it is worth noting that the forces are outside of any single entity’s control. There have been policy responses, and it will take some time to see the effects.
The supply shock is still very much with us with Covid lockdowns elsewhere in the world and the Ukraine-Russia war. Consumer spending is still reflecting additional pent up demand. The Fed’s aggressive response of raising interest rates aims to reduce demand.
I don’t make a practice of making predictions, but the consensus from the bond market based on the breakeven inflation rate published by the St. Louis Fed gives us some insights into expectations.
The current rates point to a 2.6% inflation rate over the next five years and 2.3% over the next 10 years*. While it might sting in the short term, these readings imply that the market thinks the Fed can rein in inflation using the tools at its disposal.
So, in the short term, what can you do?
How to Deal with Inflation
If you’re in accumulation mode…
Money held in savings accounts hasn’t grown much in previous years due to historically low interest rates. But with inflation now running high, your savings are at risk of losing value in ‘real’ terms as you’ll be able to buy less with your money.
Investing your money over the medium to long term may give you a better chance of beating inflation.
Younger investors who are in accumulation mode and do not intend to spend from their investments are likely wanting to outpace inflation. Here, a high allocation to equities may be warranted, depending on your goals, risk tolerance, and overall plan.
If you have near-term expenses to hedge…
Risk averse investors or those approaching or in retirement may seek out the more consistent returns of investments in bonds and bond funds to beat inflation. I-bonds or a short-term TIPS fund can be added to your overall portfolio These investments should be discussed with your financial advisor before making any investment.
I-bonds hold a unique position within an investment portfolio. With restrictions on where and how much can be purchased, I-bonds are important to help you fight inflation and market volatility. They are a low-risk treasury bond investment that provides a return that hedges inflation.
You can purchase I-bonds through Treasury Direct. The current composite interest rate through October 2022 is 9.62%! There are liquidity and investment restrictions, however.
Treasury Inflation Protected Securities (TIPS) are also US government bonds that are indexed to inflation (CPI) but are traded on the secondary market. They offer an inflation hedge in a portfolio but can also bring volatility with unexpected changes in inflation.
Commodities (like livestock, energy, agriculture, and industrial metals) have performed similarly to inflation over the long-term, but there have been periods of high volatility and underperformance relative to inflation as well.
Gold is at a historically high price, and because it does not produce cash flows like a stock or a bond, it is difficult to predict a positive future expected return. Buying now at a peak price might very well backfire. Investing in gold also comes with its own unique set of challenges. If you buy gold, you have to find a secure location to store it, which comes with costs of its own.
If you have investments…
Most investors aim to increase their long-term purchasing power. Inflation puts this goal at risk as investment returns must first keep up with the rate of inflation in order to increase real purchasing power.
Investors may want to consider inflation-mitigating assets, as well as to keep in mind the core tenets of investing—maintaining a well-diversified portfolio, regular rebalancing, and ensuring investments remain aligned with long-term goals.
All investors can benefit from the following planning strategies:
- Review your financial plan and projections with a higher inflation rate
- Review your cash flow and make a plan for increased expenses
- Review your homeowners insurance to make sure that your current coverage would be sufficient for repair or replacement costs
There’s no sure way to protect your money from the effects of inflation. So while you can’t control the cost of things, you can control the way you think about your money.
Our purchasing power may be on the decline, but we still have choices within our control to manage our personal economy. Focus on spending your money on things that bring value to your life. The importance of being intentional with our purchases is now more vital than ever.
Lastly, one of the most effective ways to keep inflation from derailing your financial plan is to speak with a professional. In the face of inflation a financial advisor can help you stay on track towards your financial goals. If you’d like to speak with us here at Abeona Wealth, we’d be happy to help.
*As of June 30, 2022; Source: St. Louis FRED