If you drive a car, chances are you’re feeling the “pain at the pump” caused by inflationary pressures and global supply chain disruptions caused by Russia’s invasion of Ukraine, which have driven up gasoline prices in recent months. But the sticker shock goes beyond gas stations. In 2021, the rate of inflation, as measured by the Consumer Price Index, increased by 7.0%, the largest annual change in the cost of living since the early 1980s.
What does this mean for consumers? Put simply, the cost of an average basket of goods has risen by 7% in just one year – and it remains to be seen how long it will take for inflation to subside. While much attention is paid to the impact this has on short-term purchases like food and clothing, it’s also important to consider the impact this could have on your investments. Consider that over the ten-year period ending in 2020, the median annual inflation rate was 1.7%. At this level, it would take more than 40 years for the cost of living 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 wallet is built to withstand these challenges, here’s some information to help you decide:
Investment Considerations in Times of Inflation
First, remember that the change in the inflationary environment does not necessarily mean that it is prudent to drastically change your investments. If your portfolio is well balanced given your risk tolerance and time horizon, fine-tuning your investments may be a more appropriate strategy.
In general, stocks (also called equities) play an important role in long-term portfolios. Compared to other asset classes, equities may experience greater short-term volatility. However, they historically generate superior long-term returns and should be positioned to do so in your portfolio, particularly if you have a long-term horizon. Investing in stocks regularly through pension plan contributions can be an effective way to build your stock portfolio in a volatile market environment. Systematic investing can allow you to buy more shares of an investment for less 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, especially with the cost of living as high as it is today. If this concerns you, investing in Treasury Inflation Protected Securities (TIPS) is an option to consider. They are marketable securities that pay a fixed rate of interest, but the underlying value of the bond is adjusted by the rate of inflation.
I-Bonds, a form of US savings bonds, also deserve to be considered an inflation-linked fixed income investment. You can invest up to $10,000 per year in these bonds. The interest rate paid is adjusted every six months according to the rate of inflation. At the start of 2022, I-Bonds pay a yield of 7.12%. However, these bonds are not completely liquid, so your money should be committed for at least one year, with full liquidity being reached in five years.
Other investment options
There are other investments that offer the potential for diversification in times of high inflation. This includes real estate, which can 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 provide immediate access to the real estate market. Precious metals such as gold can act as a hedge against inflation. However, gold is a very volatile asset class and should not 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 the state of your portfolio and your overall financial plan in today’s economy. Your advisor can help you assess how to manage your day-to-day expenses more effectively while keeping your most important savings goals on track.