How To Invest During a Period of High Inflation
Managing your finances can be difficult, especially during a period of high inflation. Fortunately, there are some things you can do to keep the effects of rising prices from eating away at your finances, particularly your investment portfolio. Read on for some helpful tips to combat inflation.
- Written By Thomas J. Brock, CFA®, CPA
Thomas J. Brock, CFA®, CPA
Investment Management and Finance Professional
Thomas Brock, CFA®, CPA, is a financial professional with over 20 years of experience in investments, corporate finance and accounting. He currently oversees the investment operation for a $4 billion super-regional insurance carrier.Read More
- Edited BySavannah Hanson
Savannah Hanson is an accomplished writer, editor and content marketer. She joined Annuity.org as a financial editor in 2021 and uses her passion for educating readers on complex topics to guide visitors toward the path of financial literacy.Read More
- Financially Reviewed ByChip Stapleton
Chip Stapleton is a financial advisor who has spent the past several years of his career working primarily in financial planning and wealth management. He is a FINRA Series 7 and Series 66 license holder and CFA Level II candidate.Read More
- Updated: September 20, 2022
- This page features 2 Cited Research Articles
- Edited By
What Is Inflation?
Inflation is an increase in the price of commonly used goods and services in an economy. In the United States, this metric is most frequently measured by changes in the Consumer Price Index (CPI), a weighted average of the prices of a hypothetical basket of essential goods and services.
For the 12-month period ending February 28, 2022, the CPI rose a whopping 7.9% — the largest increase reported in over 40 years. If you exclude volatile food and energy products, the increase remains elevated, at 6.4%.
Many factors have contributed to the price increases, including supply chain disruptions caused by COVID-19, surging consumer demand for products and mounting wage pressures across various areas of the economy. In the wake of the war in Ukraine, severe geopolitical stress is fanning the flames. These factors, in combination, pose a significant risk to the average U.S. consumer.
How Can Inflation Affect My Finances?
A moderate and consistent degree of inflation (the historical target is 2%) is generally considered a sign of economic health, but rapid price increases can have a destabilizing effect on an economy and jeopardize your hard-earned savings. The problem is most significant for households with lower income levels and for retirees living on tight budgets.
Over time, the pressures of inflation can diminish the purchasing power of your income, leaving you scrambling to cover rising housing costs, food prices, energy bills and medical expenses. The results can be devastating to your personal finance situation.
How Can I Protect My Finances During Inflation?
Fortunately, there are ways to protect your finances from the effects of inflation. A standard, foundational approach is to maintain a flexible budget, which means you’re able to temporarily decrease your everyday living expenses during challenging times.
Not everyone may be able to do this, but for those who are, the benefits can be immense. By adjusting your lifestyle and decreasing your expenses during hard times, you’ll be better able to ride out financial difficulties, preserve your hard-earned savings, avoid making poorly timed asset sales and gain a sense of financial peace.
Another way to protect your investment portfolio during a period of inflation is by investing in assets designed to hedge against inflation. Such assets have a high probability of generating additional income and increasing in value in the face of rising prices. Let’s discuss the best investments to own in periods of inflation.
High-yield, Floating-rate Bank Loans
High-yield bank loans (HYBLs), which are often referred to as leveraged loans, are another effective way to protect your finances from inflation. The protective nature of these loans stems from the fact that their interest rates periodically reset to keep pace with the prevailing market rates, which are strongly correlated with inflation.
The corporations that issue HYBLs have credit ratings below investment grade (also known as non-investment grade), which should give you a reason to pause if you’re a credit-focused investor. However, to secure the loans, the corporations are generally required to pledge that they have adequate collateral to repay the loans. This pledge can help negate any concerns about creditworthiness.
Regardless, it’s important to note that during times of economic distress, assets like HYBLs can demonstrate equity-like volatility. As a result, they experience periods of illiquidity, when the assets are not able to be quickly or easily converted into cash without a loss in value. To minimize your exposure to this risk, be sure to invest in HYBLs via a fund-style vehicle with many individual positions.
Another time-tested method of protecting against economic downturn is to invest in precious metals such as gold, silver and platinum. Historically, these assets have shown a high degree of resiliency during prolonged periods of inflation. Investing in precious metals can also help diversify your portfolio if it’s comprised mostly of stocks and bonds.
Precious metal investments do have a major drawback, however — they do not yield any income. When interest rates rise, which often happens during periods of inflation to combat the effects, precious metals can significantly underperform financial securities.
Given this conundrum, some fee-based providers of precious metals may encourage you to time the market, moving into and out of precious metals as the landscape shifts. However, this is poor advice and highly discouraged. Timing the market successfully is extremely difficult, and it’s debatable whether anyone has been able to consistently do so.
A more sensible approach is to establish a strategic allocation of precious metals (perhaps 5% to 10%) in your long-term investment strategy. This modest allocation can provide a source of strength during inflationary periods and may improve the overall efficiency of your portfolio (i.e., risk vs. return).
If you want to make ongoing investments in precious metals, you can do it in a few ways. Metals can be purchased directly, but the storage costs can be prohibitive. Alternatively, you can gain exposure indirectly by investing in diversified, metals-focused funds.
Historically, commercial real estate (CRE) has been another effective hedge against inflation. CRE includes any property that is owned and operated for the purpose of generating economic value. This differs from residential real estate, which is used primarily for living space.
Most CRE assets generate income via lease arrangements. These arrangements can include homes, apartment buildings, storage complexes, office buildings, shopping centers and industrial facilities. The ability for CRE investments to protect against inflation stems from the fact that, as inflation rises, so do property values and monthly rents.
The rise in property values and rents enables owners of CRE to maintain the real value of their properties while generating higher incomes over time. Of course, the extent to which this occurs depends on many factors, including the balance of supply and demand in the area around the property.
Investors can buy real estate directly or invest in it indirectly via the shares of real estate investment trusts (REITs) and other specialized funds. Directly investing in real estate can be lucrative and comes with several tax advantages, but the process can cost a lot of money up front and involve significant expenses for transactions and maintenance. Share-based ownership of real estate sidesteps these disadvantages, providing investors a more efficient way to establish a diversified real estate portfolio.
A final asset class that can protect against inflation is the collection of publicly traded equities commonly known as stocks. Essentially, this asset class gives investors the ability to buy a proportional ownership stake in virtually any publicly traded company in the world.
In a general sense, cyclical stocks, which move in tandem with the overall economy, are the most effective at battling inflation. Even stronger are investments in cyclical stocks that also have high growth potential.
The relatively high return potential and pricing power of these types of companies can easily reinforce the real, long-term value of your financial portfolio. However, you must be prepared to withstand the short-term volatility that equities tend to exhibit.
While a moderate degree of inflation is generally good for the economy, rapid inflation can be disastrous, especially if you don’t have much income or you’re retired. Fortunately, you can take certain measures to protect against this risk.
- Maintaining a flexible budget that allows for temporary lifestyle changes
- Proactively structuring your portfolio to include smart positions in asset classes that minimize the effects of inflation
While the first strategy can be challenging to implement, it proves invaluable due to the financial breathing room it gives you. The second strategy is sensible for anyone with an investment portfolio, whether your assets are housed in a tax-advantaged retirement account, a taxable custodial account or both.
It’s important to note that your efforts to mitigate the effects of inflation should not dominate the design of your financial portfolio. Rather, the strategies should complement your overall investment strategy.
Always strive to maintain a holistic view of what you’re hoping to achieve with your investments and your investing horizon. Don’t lose sight of your need to preserve capital, generate income, grow your wealth and manage liquidity. If you haven’t considered these needs or you lack a clear understanding of how to address them, consult with a reputable financial advisor to assess your situation.
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2 Cited Research Articles
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