What Does Inflation Mean for My Investments?

The good news is actually great. Vaccines are being delivered and millions of Americans are on their way toward full protection from Covid-19.

That means the economy will get back into gear, sooner or later, and that many of the millions who lost work are likely to be rehired.

What this also means, of course, is that some market pundits are beginning to worry about inflation.

Should you? And what about your investments? Let’s break this down piece by piece.

Inflation is not a bad thing if it’s steady and controlled. The economy has lived with around 3% annual inflation for many decades. In fact, very low inflation was considered a serious problem only recently.

The reason why is a bit chicken-and-egg. Economists look at inflation as the the “pulse” of the economy itself. A flat-lining pulse is bad news.

The opposite, deflation or falling prices, is a very bad sign. Deflation risk is why the Federal Reserve has made some much money available to borrowers over recent years, and why interest rates have stayed low for much of that time.

So what if inflation goes up? Problem solved, right? Well, within reason. Anyone over the age of 60 today certainly remembers the roaring inflation of the late 1970s.

Inflation then was driven in part by suddenly higher oil prices, but mostly the economy had gotten access to too much money in the previous decade, so it took drastic measures in the early 1980s to put on the brakes.

What followed was something economists now call the “Great Moderation.” Steady inflation, calm markets and wealth-building growth in the stock market.

If inflation really does begin to tick upward, the fundamental question is whether the trend is temporary, due to the recovery from the pandemic, or something far more lasting and harder to manage.

If the latter turns out to be the case, one would expect the Fed to again hit the brakes in order to slow rising prices. It would seek to reduce the availability of money by making borrowing more expensive.

Balance

Tap too soft and inflation rises anyway. Tap too hard and we risk a recession and possibly a market correction.

So which is it? Nobody really knows. The best way to manage through periods of uncertainty like this is to make sure that you’re portfolio is properly balanced.

If interest rates rise, you should expect bond prices to fall. This risk is greater if you own long bonds, such as 30-year Treasuries. Portfolios with shorter-term bonds, those that mature in 10 years or less, will feel less pain.

Stocks can rise despite inflationary pressures, but some stocks will do better and some will do worse. The best way to get ahead of that issue is to own a widely diversified portfolio of stocks from many sectors through a index fund or broad-market mutual fund.

Finally, rebalancing your portfolio periodically will help you sell some of your winners and buy things which are cheaper and out of favor.

It’s counterintuitive, but even the “losers” in your portfolio that might be affected negatively by inflation will recover and do well in time. Buying them on the downturn is a powerful way to ensure steady, positive gains over the long run.

MarketRiders, Inc. is a registered investment adviser.  Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies.  Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.