If you drive a car, chances are you’re feeling the “pain at the pump” caused by inflationary pressures and global supply chain disruptions from Russia’s invasion of Ukraine that have caused the price of gasoline to surge in recent months. But the sticker shock goes beyond gas stations. In 2021, the inflation rate, as measured by the Consumer Price Index, rose by 7.0%, the largest annual change in living costs since the early 1980s.
What does this mean for consumers? In basic terms, the cost of an average basket of goods rose seven percent in just one year — and it remains to be seen how long it will take for inflation to cool down. While much attention is paid to how this is impacting short-term purchases like food and clothing, it’s also important to consider the toll it could take on your investments. Consider that over the 10 year period ending in 2020, the median annual inflation rate was 1.7%. At that level, it would take more than 40 years for living costs to double. If, as was the case in 2021, the annual inflation rate averaged 7% per year, the cost-of-living would double in just over ten years.
If you’re wondering if your portfolio is built to withstand these challenges, here is some information to help you decide:
Investment considerations in inflationary times
First, remember that the change in the inflationary environment does not necessarily mean it’s prudent to dramatically alter your investments. If your portfolio is appropriately balanced with your risk tolerance and time horizon in mind, fine tuning your investments may be a more appropriate strategy.
In general, equities (also known as stocks) play an important role in long-term portfolios. Compared to other asset classes, stocks may experience more volatility in the short term. However, they historically generate superior returns over the long term and should be positioned to do so in your portfolio, particularly if you have a long time horizon. Making regular investments in equities through retirement plan contributions can be an effective way to build your equity holdings in a volatile market environment. Systematic investing can enable you to buy more shares of an investment at a lower expense when markets are down and pay for fewer shares when prices are up.
Fixed income investments
Bond yields don’t always keep pace with inflation, particularly with living costs as high as they are today. If you’re concerned about this, investing in Treasury Inflation Protected Securities (TIPS) is one option to consider. These are marketable securities that pay a set rate of interest, but the underlying value of the bond is adjusted based on the inflation rate.
Also worth considering as a fixed income investment tied to inflation are I-Bonds, a form of US Savings Bonds. You can invest up to $10,000 per year in these bonds. The interest rate paid is adjusted every six months based on the inflation rate. In early 2022, I-Bonds are paying a yield of 7.12%. However, these bonds are not completely liquid, so your money needs to be committed for at least a year, with full liquidity reached in five years.
Other investment options
There are other investments that offer diversification potential in a high inflation period. This includes real estate, which may see rising values and higher income streams that often tend to reflect changes in the cost-of-living. Real Estate Investment Trusts are marketable securities that offer ready access to the real estate market. Precious metals such as gold can play a role as a hedge against inflation. However, gold is a highly volatile asset class and shouldn’t represent more than a small percentage of your portfolio.
A good time to plan
It can be beneficial to sit down with your financial advisor to more carefully assess how your portfolio and overall financial plan are situated in today’s economy. Your advisor can help you assess how to manage your current expenses more efficiently while still keeping your most important savings goals on track.
Bronwyn L. Martin, is a financial advisor and chartered financial consultant with Martin’s Financial Consulting Group, a financial wealth advisory practice of Ameriprise Financial Services LLC. in Kennett Square and Havre de Grace, Md. She specializes in fee-based financial planning and asset management strategies and has been in practice for more than 22 years. To contact her from her: www.ameripriseadvisors.com/bronwyn.x.martin