Inflation is a normal part of a growing economy, but it can become a significant obstacle to reaching your investing goals if you’re not careful. As inflation rises, your purchasing power erodes and it can make even simple decisions like shopping for groceries more complicated. While no investment strategy can fully protect you from rising costs, incorporating some asset classes and strategies into your portfolio can help ease the burden of higher inflation on your savings and investments.
Some of the most effective investments for protecting against high inflation include gold and commodities, as well as real estate and TIPS (Treasury Inflation-Protected Securities). Investors who don’t have much exposure to these investments can seek to diversify their portfolios by adding them to an existing mix of stocks and bonds or creating a new allocation that emphasizes these assets over other types of assets.
As a general rule, investments that sell goods or services that people need tend to do better during inflationary periods than those that are discretionary in nature, such as luxury goods or recreational vehicles. This is because people tend to cut back on non-essential spending when inflation rises, which can lead to a boost for businesses that provide the necessities, such as utilities, consumer staples and insurance companies.
Many investors are tempted to retreat into cash during times of high inflation, but this may be counterproductive. Cash is often considered low-risk and can offer the illusion of stability, but it also loses purchasing power over time due to inflation. Moreover, missing out on the market’s best days may significantly erode your wealth over time, especially if inflation is persistently high.
Some popular asset class strategies, such as the 60/40 portfolio, have been designed with a view of low fixed income volatility and stable correlations between equities and bonds during inflationary periods. However, with inflation accelerating and interest rates rising, these strategies may have limited effectiveness.
Generally, longer-term fixed-income investments such as bonds and money market funds perform well during inflationary environments. Short-term alternatives, such as short-term TIPS, are typically more volatile and less correlated with stocks during inflationary periods.
When it comes to inflation, the best thing you can do is stay informed and be ready to act as prices increase. Keep an eye on inflation trends, consider your own personal spending habits and be prepared to adjust your portfolio as needed.
Joshua Rodriguez is a personal finance and investing writer and financial advisor. He is a CERTIFIED FINANCIAL PLANNERTM practitioner and member of the American Institute of CPAs. He lives in Colorado with his wife and two children. His work has appeared in Forbes, The Wall Street Journal and Reuters.
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