by Colleen Kelleher Sorrentino, Stacey Mankoff, 7/2/24
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Inflation can impact your investment portfolio by slowly eroding its value, silently reducing your purchasing power. To protect your investments and ensure they retain their value over time, you must implement proactive strategies that combat the effects of inflation. In this article, we discuss seven strategies to help shield your investments from inflation’s impact.
Diversification
Diversification is one of the most critical strategies to protect your investments against the effects of inflation. By allocating your investments across various asset classes you can reduce the risk of inflation significantly reducing the value of your portfolio. Different asset classes tend to react differently to inflationary pressures so having a mix of investments will help stablize your overall portfolio during periods of rising prices.
Stocks
Stocks are a reliable hedge against inflation due to several key factors. First, companies have the ability to adjust prices for products and services, allowing them to maintain or even increase profit margins in inflationary environments. This ability of passing on increased costs to consumers helps protect the value of the investment. Additionally, stocks represent ownership in real businesses which often adapt to inflationary pressures through innovation, expanding into new markets or improving their efficiencies.
Stocks historically have outperformed other asset classes over the long term, helping investors preserve purchasing power even in inflationary periods. For investors looking to hedge against inflation, focusing on stocks of companies with strong pricing power, stable earnings and a history of dividend growth may provide a solid strategy to protect their investment portfolios.
Real assets
Real assets, such as real estate, infrastructure, and commodities, are tangible investments with intrinsic value due to their physical properties and practical uses. Real assets often move in line with inflation. For instance, real estate values and rental incomes tend to rise as inflation increases. Property owners can adjust rents to match higher price levels, helping to preserve the real value of their investments. According to Realtor Magazine, historically, during high inflation periods such as the 1970s, real estate investments often outperformed other asset classes, providing significant protection against inflation.1
Commodities are another real asset investment. Commodities like gold, oil and agricultural products are closely linked to inflation. When inflation rises, the prices of these commodities typically increase as well. For instance, during the inflationary period of 2007-2008, commodity prices surged, with oil reaching record highs.2 Gold saw substantial gains during this time, highlighting its role as an effective inflation hedge. Agricultural commodities, such as wheat and soybeans, also tend to see price increases during inflationary periods due to higher production costs and increased demand.
Real assets often have a low correlation with traditional financial assets like stocks and bonds. This diversification reduces overall portfolio volatility and offers inflation-linked income, providing diversification benefits to your portfolio.
Treasury Inflation-Protected Securities (TIPS)
TIPS’ principal value adjusts with the Consumer Price Index (CPI), thus preserving your investment’s real value and purchasing power. During periods of high inflation, TIPS ensures that returns keep pace with rising prices and the interest payments adjust with inflation, providing consistent, reliable income which is ideal for retirees. TIPS are backed by the US government and are virtually credit-risk-free.
Dividend-Paying Stocks
These types of stocks can provide a steady income stream to mitigate the effects of inflation on your portfolio. Investing in companies with a strong history of dividend growth and sustainable payout ratios will help to preserve your purchasing power and maintain your investment’s real value.
Shorter-term bonds
Shorter-term bonds generally exhibit less sensitivity to interest rate changes than longer-term bonds, reducing the impact of inflation on your portfolio. By investing in bonds with maturities of five years or less, you can better manage interest rate risk and preserve your investment’s value. This strategy helps maintain stability and provides a buffer against inflation’s eroding effects on your bond portfolio.
Review and rebalance
Investors should regularly review and rebalance their investment portfolios to ensure their portfolio remains aligned with their financial goals and risk tolerance. By rebalancing, you can maintain your desired asset allocation and risk level, adjust to market changes and preserve your investments’ value. This proactive approach helps manage risk and optimize returns and provides stability while protecting your portfolio against the eroding effects of inflation.
Although inflation can erode the value of your investment portfolio, there are measures you can implement to minimize its impact. It is important to be aware of these steps as and to have an open and frank discussion with your financial advisor about your investment goals and risk tolerance. Together, you can make the best decisions on protecting and growing your investment portfolio.
Colleen Kelleher Sorrentino, CFA® is with Kelleher Financial Advisors, a New York-based investment advisor. Stacey Mankoff is with The Mankoff Company LLC, a New York-based marketing firm serving the financial industry.