Wishing you could inflation-proof your finances? You’re not alone. While everyone is subject to the effects of inflation, there are a few things you can do to minimize its impact on your investment portfolio.
Inflation is being talked about and felt everywhere these days. This loss of purchasing power (meaning your dollar won’t go as far tomorrow as it did today) is evidenced by the consumer price index, which increased 7% over the 12-month period ending in December 2021 —the fastest increase since 1982.
Inflation is a fact of life and of investing. This means that there is no such thing as inflation proofing or sheltering your finances entirely from the effects of inflation; however, you must consider inflation as part of your overall investment strategy.
A solid financial plan is one of the most effective ways to hedge against inflation.
Of course, there’s zero way to hedge 100% of inflation risk. But having a long-term, comprehensive plan can prepare you and your finances for a strong financial future. A solid financial plan takes into account your current financial situation, your long-term goals, and your willingness and ability to take risk.
This is an area where working with a wealth advisor becomes truly invaluable: Your financial plan serves as a north star to guide all your investment decisions, allowing you to invest according to a thoughtful, well-considered strategy, not according to your emotions or with knee-jerk reactions to economic conditions.
Stay invested — It’s the only way to make your money grow.
It may sound simple, but the worst thing you can do is stick your cash under the proverbial mattress when times get tough, and especially when inflation is part of the equation. Leaving too much of your money in a savings account when you could be investing it is almost as bad. The moral of the story? Cash simply can’t keep pace with inflation.
What to invest in, then? The type of investment certainly matters when it comes to inflation, and staying diversified does, too (more on diversification below).
Historically, stocks are the only investment that has outperformed inflation, when looking at long-term returns. Alternative investments, such as real estate and gold in particular, have also historically done well as hedges during inflation. As for fixed income investments, Treasury Inflation-Protected Securities (TIPS) and high yield bonds are considered to be resistant to inflation.
Carefully consider the risk and investment types with your wealth advisor to ensure they fit with your plan.
Consider reducing your exposure to certain types of investments.
Certain investments are more susceptible to inflation risk than others, including fixed-income securities and fixed-rate bonds. When you invest in bonds, you receive a fixed coupon rate, or interest rate, that never changes, regardless of inflation. If inflation rates increase above the coupon rate for long-term bonds, loss is inevitable.
If, as an example, you had purchased a 30-year bond last year that paid a 3% coupon rate, you would have lost purchasing power since inflation has far outpaced that rate.
Stay diversified to help mitigate the effects of inflation.
Even though investment type matters, you shouldn’t rely on a single investment type or even flee certain investments just because they don’t look so good at this exact moment. When you’re diversified, you retain the proper mix of investments in your portfolio (as guided by your financial plan).
Investing for the long term in a well-diversified portfolio helps build in inflation protection. You can ensure your portfolio is well diversified by working with your wealth advisor to appropriately allocate assets.
What concerns do you have about managing your wealth in light of these conditions in 2022? Ironwood Wealth Management is here to help you mitigate the effects of inflation using disciplined principles and investing practices. Contact us to learn more about how we can help.
