How Our Portfolios Protect Against Inflation
With the Fed’s wait-and-see approach on inflation, consumers and investors run the risk of the economy overheating and inflation getting out of control. This is concerning because it could cause the Fed to increase interest rates at a faster pace than it otherwise would have, and it potentially means that the items we purchase would more quickly increase in price.Fortunately, we seek to manage inflation risk in the design of our portfolios. Stocks are one of the few assets that generate a meaningful return after adjusting for inflation, and that growth potential is why we include some allocation to them in almost all of our portfolio recommendations. Growing wealth in excess of inflation is critical to most people’s financial and life goals. Additionally, our preference for investing in value (i.e., inexpensively priced) stocks acts as quasi-inflation insurance, because value stocks have historically performed well during past periods of heightened inflation.
The use of short- to intermediate-term bonds in your portfolio not only helps stabilize the ups and downs that come from stock investing, but these bonds also perform better versus long-term bonds when interest rates rise. Because bond prices fall when interest rates rise, anytime the Fed considers increasing interest rates or investors push interest rates higher, the bonds in our portfolio will likely decline in value. Short- to intermediate-term bonds are less sensitive to this risk than long-term bonds.
Like it or not, inflation is always present in our world. As the economy emerges from the pandemic, we should expect inflation to be higher than we’ve seen in the recent past, and, if the Fed is correct, it should moderate at some point in the somewhat not-too-distant future. The good news is that we have considered these risks and proactively build financial plans and investment portfolios with strategies to help mitigate some of the potential challenges that inflation presents.