Tips for Optimizing Your Investments Amid Inflation
While higher inflation can be worrying, a modest amount of inflation can encourage spending, borrowing and lending, which in turn keep the economy strong and growing. We’re seeing signs of a strong economy today, with low unemployment, rising wages and healthy amounts of consumer spending.
The Federal Reserve’s long-term target for inflation to ensure “maximum employment and price stability” is 2%1. When inflation climbs past that target, we see another effect – consumer purchasing power decreases. Many companies pay higher wages but also pay more for materials, so in turn, they must charge more for their products or services. For those on fixed incomes or who are retired, these elevated costs can be especially challenging. Finally, high inflation can cause uncertainty in the stock market due to a slowdown in spending, and bond prices can be impacted too.
Navigating the effects of inflation requires a thoughtful approach to financial planning and investment strategy. Below are several considerations to help optimize investments during inflationary periods.
Start with the basics
Reviewing or establishing a financial plan is a practical first step in a high-inflation environment. Begin with a budget that reflects current costs for goods and services, and adjust discretionary spending as needed. It’s also important to evaluate short- and long-term financial goals and assess how market conditions may influence them.
Understanding cash flow needs is essential, as spending patterns often change year after year. Tracking expenses, managing debt, and maintaining savings goals can help build a strong financial foundation.
Focus on diversification
With a strong financial plan in place, attention can shift to investment strategy. Diversification remains a key principle, helping to balance risk and reward across asset classes. While all investments carry some level of risk, diversifying can help mitigate specific types, including:
- Credit risk: Risk due to the borrower not repaying the loan.
- Inflation risk: Risk of loss due to rising prices of goods and services.
- Interest-rate risk: Risk due to interest rate fluctuation.
- Equity risk: Risk due to changes in stock prices.
- Commodity risk: Risk due to changes in the price of commodities.
Reducing investment risk with diversification is an important part to your investment strategy. For example, investing in all fixed-income bonds will reduce equity risk, but would mean you have credit risk and inflation risk. Having a cash-only account would eliminate multiple types of risk, but now you are losing purchasing power because of inflation. Stocks are generally seen as a good hedge to inflation, but they come with equity risk. You cannot eliminate all types of risk from your investment portfolio, but you can reduce the impact of certain risks with diversification.
Once you have the fundamentals down, discuss other strategies with your financial advisor. There might be options that you didn’t think of, such as hanging on to lower interest rate debt and taking advantage of higher interest rate accounts instead of paying off debt at a lower rate. With the Fed increasing interest rates, this has also resulted in higher rates on certificates of deposit, money market accounts, bonds and Treasury bonds.
Speak with your wealth advisor regularly to review your goals and optimize the diversity in your accounts. If you have multiple accounts with multiple advisors, it’s a good idea to have at least one advisor who can view all your accounts to make sure that they work in concert with one another rather than against each other.
Inflationary times can be challenging for investors. However, you can find some confidence by employing fundamental financial strategies and diversifying your investments.
1 https://www.federalreserve.gov/faqs/economy_14400.htm
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