How to fight inflation in your portfolio
Whether you’re filling your gas tank or stocking the fridge with groceries, prices seem higher everywhere.
Last year we saw consumer prices increase by 7%, the biggest increase in almost 40 years. Americans are now faced with something they haven’t had to worry about much for the past 30 years, inflation.
What is the cause of the increase in inflation? Supply chain disruptions due to COVID-19 and increased money supply are the two main drivers. The coronavirus shutdowns have created a bottleneck in supply chains. Factories were unable to produce goods as demand remained high. Combine that with the increased money supply due to stimulus packages and you have a scenario of high demand with limited supply – a perfect equation for rising prices.
How long will it last, how high will it go? In early 2021, when we started to see the first signs of rising inflation, the Federal Reserve called the price increase “transitional” or temporary.
They have since acknowledged that inflation was more rigid than initially expected. However, they expect inflation to start to subside this year and their long-term inflation expectations are in the low 2% range.
However, some economists disagree with the Fed’s optimistic outlook and believe that this high level of inflation will be with us for a few years until the effects of the coronavirus shutdowns are felt in the economy. . It is also important to keep in mind that there are two types of inflation, sticky and flexible.
Sticky inflation tends to last longer. Fortunately, we have seen the biggest increase in flexible inflation, things like food, energy and commodities. Price increases in these regions tend to be more short-term.
Think about timber prices in 2021. We saw the price of timber skyrocket in the first half of 2021 before falling back down in the second half.
How do I protect my portfolio from inflation? Inflation is not always a bad thing. For example, moderate inflation has been good for the markets because it generally indicates a strong economy.
The risk comes with rising and high inflation. Fortunately, not all asset classes react in the same way when inflation rises. There have been eight periods of rising inflation since 1970 and there have been four asset classes that have provided the best returns during those periods.
Investors should be aware of how their assets are allocated to ensure they are in the correct areas to minimize the adverse effects of inflation.
Also, higher inflation is usually accompanied by higher interest rates. The Fed has previously hinted at raising interest rates earlier than expected due to rising inflation. On the one hand, savers can expect to earn a higher interest rate on their short-term savings and money market accounts. On the other hand, bond investors should be aware of the interest rate risk of their portfolio.
Bonds have an inverse relationship with interest rates. When rates go up, bond prices go down. That doesn’t mean you should avoid bonds; you just need to make sure you are well positioned to manage the risk.
The future is always uncertain, but it is this uncertainty that gives investors the opportunity to make profits. Investors should stay calm and review their portfolio design before making rash decisions. I believe a well-balanced portfolio can help investors prosper for years to come.
• John P. Daly is the founder of Daly Investment Management LLC, a registered investment adviser specializing in wealth management and retirement planning. For more information, visit www.dalyinvestment.com