Inflation has been showing up everywhere in the news recently.
In the United States, President Biden’s recent annual “State of the Union” speech focused heavily on how to curb the effects of inflation for American citizens.
Experts note that inflation rates in the United States are higher than they have been since the 1980’s- and for a number of reasons, they are expected to stick around.
And in the Eurozone, inflation rates have been reaching record highs.
So with the highest inflation rates the world has seen in decades causing concern for consumers and investors alike, what does this mean for your investment portfolio?
While it may seem that inflation will inevitably affect all of your investments; however, that is not actually the case.
In this article, we will explore how inflation affects different types of investments, and share some helpful strategies for keeping your portfolio safe from rising inflation rates.
How does inflation affect different types of investments?
It should go without saying that not all investments will be affected in the same way, or to the same extent, by high inflation rates.
It is always good to diversify your portfolio, but as you do so you will want to know which types of investments are more inflation-proof.
Let’s take a look at how different types of investments will be affected by inflation.
Liquid cash is particularly susceptible to the rising and falling rates of inflation.
While consumer prices may grow, the interest rates on personal bank accounts can remain extremely low, which means that due to rising inflation rates, any liquid cash held in savings is not increasing in value to match the higher market prices.
Particularly for younger investors, it is important to have an emergency supply of enough liquid cash to cover roughly three to six months of living expenses.
You should also maintain your savings for other major planned expenses, such as buying a home or covering medical expenses for young children.
Otherwise, the cash you have is not really well-protected from inflation.
It’s advisable that you keep the amount of liquid savings in your portfolio to a minimum and invest the rest elsewhere.
There is a common saying that inflation is bad for bonds, and this is partially true.
Inflation chips away at the value of the principal fixed rate that bondholders will receive years down the line.
It also reduces the value of coupons that will be redeemed in the future.
However, there are some strategies that can help make bonds a viable option, such as keeping the duration low and exploring floating rate bonds.
These constitute good strategies for optimizing bond investments, even during high inflation periods.
And since government bonds include a risk-free return rate, they can be a more stable option when compared to stocks.
Higher inflation reduces peoples’ standards of living and increases the costs of labor, supplies, and borrowing costs.Thus, negatively impacting stocks.
Of course, not all stocks react the same way. Growth stocks are more likely to underperform during high inflation periods, while value stocks will remain more stable.
And the stock market does account for a certain amount of inflation throughout its dealings, so your investments may already account for rising levels.
It is only when inflation rates jump unexpectedly that there can be blowback.
Many have expected the rising value of cryptocurrencies to outpace the rising levels of inflation, making them a stable investment.
During this current wave of inflation, however, it seems that the ongoing volatility of cryptocurrencies may counteract that effect.
Inflation-proofing Your Portfolio
Now that we have explored how different types of investments are affected by inflation, we can dive deeper into how to effectively safeguard your portfolio from the effects of inflation.
Generally speaking, a portfolio that relies more heavily on bonds is at greater risk than one that stakes its claims in stocks.
If the vast majority of your portfolio is in equities, then inflation will not pose such a threat to your portfolio.
If, however, your portfolio is largely fixed income then inflation will likely have a more significant impact.
Here are some investment options that will remain safer during periods of rising inflation rates:
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Commodity investments such as oil and gold can help protect a portfolio against the effects of inflation.
The total returns of assets linked to commodities usually increase during high inflation periods.
There can be some fluctuation with commodity investments, particularly with oil, as issues linked to specific oil companies can impact the total stock prices and commodity prices.
Gold, meanwhile, remains a relatively stable option that is not overly impacted by inflation.
However, experts recommend keeping investment in gold to a minimum although it can provide an extra source of support within more extreme inflationary environments.
Floating-rate notes provide coupons that adjust to changing interest rates, which are occasionally reset to match shifts in an interest rate index. So this asset can be positively linked to inflation.
Bank stocks are a good asset to consider. They tend to offer higher interest rates which leads to the possibility of larger spreads between borrowing and lending rates.
Higher profits and more protection against inflation make bank stocks a good option.
Monitoring Your Portfolio
As you seek ways to protect your portfolio from inflation, it is important to remember that inflation is not the only possible threat to your portfolio.
Focusing exclusively on inflation-proofing your portfolio can actually prevent you from making robust gains in the long run. Consider going down different roads as well.
Know that economic problems like recession can also have a negative effect on your portfolio, but that doesn’t mean you shouldn’t invest.
Instead, monitor your portfolio and keep track of the fluctuations in the market. Keeping your portfolio balanced even amidst turbulent times in the market can sound daunting.
By keeping tabs on how inflation rates are affecting the different types of assets in your portfolio, you can make informed decisions about how to safeguard your portfolio from rising inflation rates.
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