Inflation: What We Think and Do in the Face of It

We all want to see our investments grow in value over time, aren’t we? When your balance grows and you feel more secure, it’s a terrific feeling to save and invest wisely. In order to really grasp the value of our possessions, we must go beyond the ledger lines. When we save money, our ultimate objective should be to keep and grow our buying power, and inflation may be a worry even when the markets are rising. In order to be ready for any economic situation, prudent financial planning takes inflation into consideration.

There has been a lot of talk about inflation lately, and it may be hard to tell how much of it is a hoax and how much of it is real. Despite the fact that inflation has grown by 5.4 percent over the last year, some amount of inflation is normal. Let’s take a closer look at what inflation is, how it affects our customers, and some tips for protecting your portfolio when inflation is high.

Definition: What is inflation, and how is it measured?

According to Investopedia, “the reduction in buying power of a particular currency over time” is the most fundamental definition of inflation. Despite the term “reduced buying power,” it is the rising cost of products and services that has the greatest impact on the average customer. The Consumer Price Index (CPI) published by the Bureau of Labor Statistics is a standard indicator of inflation (CPI). The average weighted cost of items is divided by the previous period’s cost in order to produce the Consumer Price Index (CPI).

Recent inflation has had a disproportionate impact in certain locations. Fuel and gasoline prices have risen by 43% and 42%, respectively, during the last year. The cost of pre-owned vehicles has also increased by 24%. If you look at core inflation, which is the CPI without food and energy, the 12-month rate falls to 4%, which is more in line with historical trends. According to a Reuters article, the Federal Reserve forecasts inflation to rise only temporarily, from 2.1% in 2022 to 2.2% in 2024. A table of 12-month percentage changes from the Bureau of Labor Statistics is available if you’d like additional information.

What’s behind this year’s spike in inflation? Inflation may be caused by a combination of three factors: rising demand, reducing supply, and rising salaries and expenses owing to anticipation of future inflation. In addition to the COVID supply chain stoppage, we’re likely to see an uptick in demand as a result of the continuing immunisation campaign and the reopening of the economy.

What is it that has people so worried?

Fears about a rise in interest rates by the Federal Reserve are commonly cited as a cause of inflationary worries. As a result, the ensuing cooling may reduce consumer demand and lead to deflationary pressures. Is it possible that the Federal Reserve may raise interest rates in order to combat inflation? What will this entail for our investments? Short-term signs of increasing rates are controversial.

Long-term investors, on the other hand, discover that the stock market’s success and fluctuations in interest rates have nothing in common. Interest rates tend to cause a drop in bond values because older, lower-yielding bonds lose their allure to younger, higher-yielding ones. In order to decrease the vulnerability of the fixed income portfolio to changes in interest rates, we allocate a greater portion of our assets to short- and intermediate-term bonds.

It’s a prevalent worry among our customers that the federal government will overspend. Two things should be kept in mind, though. When inflation is low and steady, it might be a sign that the economy’s productivity is continuously rising. Government spending doesn’t always lead to inflation, and it all relies on how the money is used. The economy and government expenditure are likened to a flower bed in this insightful article from The Guardian:

As long as you don’t overwater, you may not have to worry about spillage. Flooding and the death of flowers might occur if water is poured into an already wet area. In contrast, the water will be absorbed and the flowers will bloom whether you shower the whole bed or concentrate on the driest sections.

Furthermore, the paper points out that the 2008 financial crisis and recovery did not lead to an inflationary spiral. This decade has had the lowest inflation rate ever recorded.

What are our options?

A well-balanced, broadly diversified portfolio with a mix of assets with realistic projected returns, in our opinion, is the best strategy to guard against changing economic circumstances like inflation (total portfolio return less inflation). It’s during inflationary times like these that standing on the sidelines and hoarding too much cash may erode buying power over time. The amount divided between stocks, bonds, and other assets like real estate will vary.

Investing in certain asset classes is another way we try to stay ahead of inflation. In an inflationary climate, value companies tend to do well since investors are looking for current income and solid cash flows. The energy, consumer staples, and banking sectors are also significant in value equities and often do well during these times. Bond allocations are made with government credit in mind, which is less impacted by inflationary pressures than private-sector debt. Alternative specialized assets in real estate, reinsurance, and alternative finance are also included in Merriman portfolios.

As a result, these assets are less connected with the stock and bond markets and are predicted to return above inflation. Investors raise rents to keep pace with rising costs, which helps real estate do better when inflation is on the rise. This may be done by raising premiums each year and maintaining the collateral invested in assets that return at or above inflation. In a turbulent rate environment, alternative lenders use variable rates, which provide more flexibility. The diversity provided by specialised investments is an alternative to acquiring extra bonds, and the instruments provided by these investments may be used to react to inflation.

When it comes to investment, the impact of inflation on individual portfolios and the economy as a whole cannot be overstated. The reasons, concerns, and techniques for dealing with inflation fascinate us, and we want to give some insight to alleviate any anxieties. We at Merriman will keep a close eye on inflation to make sure we’re prepared for any changes, whether they’re up to or down.

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