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Financial Planning for Rising Inflation

The most recent Consumer Price Index inflation report showed that prices rose by quite a bit in October. Overall, prices climbed 6.2% year-over-year, the largest increase since November of 1990. This is well above the Federal Reserve’s 2% target, and more than a full percentage point ahead of the wage increase of 4.9% from October of last year. When high inflation first became an issue in the Spring of 2021, the Fed explained that it was due to several reasons: base effects, supply-chain issues, and a tricky labor market.

            To understand base effects, consider what happened during the state government-imposed lockdowns of 2020. Any year-over-year comparison was bound to look like a huge increase once people began spending more when things returned to normal. Supply chain issues are most prevalent in the used car and truck industry. Supply is limited because of new car production being down due to a computer chip shortage; people are hanging onto their leases for longer; and rental car companies have fewer used cars to unload because they decreased their inventories when the pandemic struck. Tens of millions of Americans lost or left their jobs during the Covid Recession which has resulted in a much lower level of goods being produced. While the Fed typically raises interest rates when inflation starts to take off, it is not clear whether this will help in this particular situation. Consumers will likely have to face higher prices for longer than anticipated.

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            What does all of this mean for your investment portfolio and overall financial plan? Rising prices mean that a portfolio’s investment return does not mean as much. Further complicating matters is that the stock market usually does not respond well to periods of high inflation. How can investors shield their money from the effects of inflation and maybe even take advantage of it?

            Because inflation can cause the Federal Reserve to raise interest rates, advisors recommend not holding a large portion of your portfolio in any long-term bonds or certificates of deposit. Not only does the value of a bond typically decrease as interest rates go up, but you would be locked into something long-term and not be able to take advantage of the higher rates later. Some advisors also advise investors to stay away from growth stocks because the value of future cash flow is worth less in a high interest rate environment.

            While advisors are recommending scaling back on growth stocks, they are recommending increasing their clients’ asset allocations to value stocks. These types of companies are better able to increase their prices with inflation and are not as susceptible to their expected growth decreasing in value. Treasury inflation-protected securities, or TIPS, are another good option for investors worried about inflation. While TIPS carry the same risk as other fixed income investments, they add an adjusted principal amount to the investment if inflation increases. Real estate usually performs well in a higher inflation environment because property values tend to increase, and landlords can increase their rental rates.  Investing in gold and cryptocurrencies can be beneficial amid inflation because those assets are not affected by the eroding value of cash, however because they are so volatile, advisors warn that they should not make up more than 5% of your portfolio.[i][ii]


[i] https://www.cnbc.com/2021/10/29/investors-are-worried-about-inflation-what-advisors-are-recommending.html?utm_source=Newsletter&utm_campaign=Newsletter+11%2F16&utm_id=Newsletter

[ii] https://www.forbes.com/advisor/investing/why-is-inflation-rising-right-now/?utm_source=Newsletter&utm_campaign=Newsletter+11%2F16&utm_id=Newsletter


WINSTON SAYS

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