How to protect your money from inflation
Key takeaways
- Inflation can be a challenge — especially those with little exposure to stocks and a lot of money in cash or bonds. If you believe future inflation will be an important investment consideration, taking steps to mitigate its impact may make sense.
- For most people, it can be a good idea to diversify across several different types of inflation-resistant assets and asset classes.
- That could include certain types of equity and/or fixed income investments.
- It may also help to reduce exposure to investments that are more sensitive to inflation.
Inflation has been of little concern to most people worldwide for over a decade (with some exceptions, of course). However, we have seen inflation increase virtually universally since the COVID-19 pandemic began, with other supply chain issues adding to the pressures. It could be a good time to think about adding some inflation protection to your portfolio.
Why inflation matters to your financial plan
Most people have seen inflation in action: simply put, prices go up over time. That's why most things cost more now than they did when you were younger or even a few years ago. Staying ahead of inflation may be an important reason to invest your savings in assets that offer potential growth to counteract its effects.
Some inflation is normal—and even good usually because it means the economy is growing. But inflation doesn't always behave the way it's expected to. If it's higher than expected or stays at an elevated level for a longer time than markets expect, managing investments can get tricky.
Inflation is always important from a financial planning standpoint because you want to think about long-term financial objectives relative to your purchasing power. The higher inflation may be, the higher your return target will need to be to maintain the purchasing power of your assets.
For instance, if the average annual inflation rate is expected to be 2%, to keep up with inflation an investor would need to build a portfolio with the potential to return at least 2% to maintain their purchasing power.
Some inflation is normal and usually good, but an inflation surprise usually isn't.
Inflationary pressures are often temporary. But it may make sense to have a plan just in case things don't go as expected.
What you can do
To stay ahead of inflation, look at your investment mix as a whole and evaluate where you stand. There are no simple solutions—you may need a combination of investments to provide a potential return that can keep up with the effects of rising prices. And some investments may be better for the job than others.
Stocks tend to keep up with inflation better over time than bonds because their earnings can adjust upward, due to stronger company pricing power. For younger individuals many years from retirement, with a large allocation to stocks, it may not be necessary to add much additional inflation protection.
But those closer to retirement, and retirees with a very conservative investment mix, may be exposed to higher inflation risk. By adding inflation-resistant investments to your portfolio and diversifying across asset classes, you may be able to reduce this risk. It’s not all bad news though—people who are retired may already benefit from inflation-adjusted income through government-provided benefits, defined benefit pensions (from previous employers), or annuities with cost-of-living adjustments.
These are general considerations, and not intended to be specific investment advice. You should consult with a professional financial advisor to determine which types of investments are suitable for you given your unique circumstances, objectives, time horizon and attitude to risk.
Be proactive about inflation
Like sudden market drops and economic recessions, inflation is another risk that you need to plan for. Creating an investment mix that considers your time horizon for investing, risk tolerance, and financial situation may help you weather the storms that may crop up along the way. Though you may not be able to avoid inflation completely, taking steps to protect your portfolio from it may mitigate some of its impact and help keep you on track to your goals. Speak to a professional financial advisor about an investment portfolio that can best address your concerns and that allows for your unique circumstances.
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