A dollar today won’t buy what it did 10 years ago or 10 years in the future. The decrease in buying power over time is due to inflation. Understanding how high inflation impacts different kinds of investments can help you gain confidence around choosing your investments.

The prices of specific goods and services can rise and fall thanks to changes in tastes (suddenly everyone wants avocado toast), or advances in manufacturing that make tech gadgets like smartphones less expensive. High inflation is when the costs of goods and services increase unexpectedly, putting them out of reach for many, especially when people’s incomes don’t increase as well.

Currently, most central banks—including the U.S. Federal Reserve—consider a 2% inflation to be “healthy.” Anything significantly above or below that level can have an adverse effect on the economy.

: unless income increases at the same rate, people are worse off, leading to lower levels of consumer spending and a fall in sales for businesses…and uncertainty, which causes even more of a slowdown.

: usually signals that demand for goods and services is beneath where it should be. This tends to slow economic growth and depress wages.

: a long period of low to moderate inflation, 1% to 3 %, with a healthy demand for goods and services, and stable prices (1).

What causes high inflation? What controls high inflation?

A war might make fuel prices skyrocket, or a shortage of a raw material or product can drive up prices. This is when governments and policymakers may step in to control inflation in a few ways.

Raising, lowering, or maintaining interest rates

 is one way that the U.S. Federal Reserve helps to regulate inflation—to cool down an overheated economy or raise the temps a bit to spur growth, which affects everything from mortgages to the price of commodities.

 Costs associated with borrowing money are higher. People and corporations tend to cut back on spending, and the economy slows—cooling both demand and inflation.

Costs associated with borrowing money are lower. People have more money and may want to buy a new car or a house. Companies can afford to purchase machinery or the latest technology. This heats up demand, jumpstarting the economy.

Imagine an army of data checkers collecting information like heating costs, and prices of groceries and gasoline and even haircuts. Economists put that data into market baskets and compare it over different time periods. One of the most frequently reported indexes of these price comparisons is the Consumer Price Index (CPI). Inflation is calculated by using the CPI (2).

People think inflation is bad for obvious reasons: prices rise, things get too expensive, and they have to make hard decisions about what to buy. However, there are situations in which inflation can be seen in a more positive light. For example, if you borrowed money before inflation began to rise, you may benefit from higher inflation., because if your income from wages is also increasing, then you’ll have more money in your pocket to pay off the debt.

Sometimes the Fed’s “fix” can cause some hardship, such as for a retiree who benefits from a pension with a fixed 3% yearly increase and who saved enough to be able to spend $50,000 per year in their retirement. But what happens when inflation is higher than 3% and rises 3% every year? That retiree who has enough saved today would instead need more than $67,000 a year in just 10 years to fund the same lifestyle—and more than $90,000 per year in 20 years (3).

Having a well-diversified portfolio can help enhance investment returns and reduce risk during times of high inflation (4). Diversification is a risk management strategy in which investors spread their investments across asset classes.

Traditionally, a diversified portfolio was seen as a mix of 60% stock and 40% bonds (5), but with today’s market disruptions and trends, that allocation can saddle investors with an underperforming portfolio. Reviewing your financial goals, risk tolerance, and strategies with your financial advisor or virtual AI investing assistant (https://magnifi.com/magnifi-personal) is essential to be able to choose the right mix of assets for you.

There are certain investments that are more inflation-tolerant than others or that even tend to rise with inflation.

The stock market’s average annual gain of 10% has outpaced inflation over the long run. However, historically, when inflation spikes, it has been a major headwind for stocks. In five of the previous seven such spikes since 1973, the S&P 500 index declined, suffering a median drop of 7.8% (6).

The ideal stocks to own in an inflationary environment are companies that can pass along higher costs to their customers because of strong demand for their products. One example is consumer staples stocks that offer necessities like food. Also, companies that raise their dividends regularly may allow you to outpace inflation.

Note that higher inflation and higher interest rates negatively impact companies that have borrowed money for equipment and technology—which is often why high-growth stocks can lose some of their value compared to value stocks, although both growth and value stocks suffer from extended periods of high inflation.

Buying global stocks (https://magnifi.com/learn/how-to-invest-for-global-exposure) can help to hedge your portfolio against a weaker US dollar. That’s because there are many major economies around the world that do not fluctuate in tandem with the US markets. In addition, rising inflation in the US can actually be advantageous for American investors in international companies whose foreign-currency profits get converted into US dollars.

Real assets such as real estate and commodities

Real assets (https://magnifi.com/learn/how-to-invest-in-real-assets) are physical assets that have an inherent value due to their physical attributes, such as commodities like gold, wheat, and oil or real estate. Real assets help diversify investment portfolios because they have a relatively low correlation with financial assets, such as stocks and bonds.

Real estate can be a popular investment if you want to outrun inflation, because property prices and rents charged by landlords typically go up during inflationary periods. Over the past 30 years, an index of U.S. real estate investment trusts (REITs) posted larger gains than the S&P 500 in five of the six years when inflation was 3% or higher (7,8).

 often prosper in inflationary times as well. That’s because as the price of goods and services rise, so does the price of the commodities used to produce those goods and services.

Investing in bonds may seem a counterintuitive way to beat inflation. However, investors can purchase inflation-indexed bonds, which protect investors from inflation. In the United States, Treasury Inflation-Protected Securities (TIPS) are a popular option because they are pegged to the government’s Consumer Price Index.

When the Consumer Price Index (CPI) rises, so does the value of a TIPS investment. And as the value adjusts higher, so does the interest, because it’s based on the adjusted value.

Direct investment in TIPS can be made through the U.S. Treasury or via a brokerage account. TIPS are also held in some 

exchange-traded funds (ETFs) and mutual funds

Investors can gain exposure to domestic and international stocks, REITs, commodities, and TIPS through ETFs and mutual funds. Searching on Magnifi shows you numerous opportunities to invest around inflation:

Georgiadis, Stavros, “What Does Inflation Do to the Stock Market?,” June 10, 2022, Investor Place, Nasdaq.com, https://www.nasdaq.com/articles/what-does-inflation-do-to-the-stock-market.

Rodini, Laura, “What Is Inflation? Definition, Formula & What It Means For You,” updated October 12, 2022, TheStreet.com, “https://www.thestreet.com/dictionary/i/inflation.

Shell, Adam, “Shield Your Portfolio From Inflation,” July 26, 2021, Kiplinger.com, https://www.kiplinger.com/investing/etfs/603178/shield-your-portfolio-from-inflation.

Diversification does not guarantee a profit or protect against a loss in a declining market. It is a method used to help manage investment risk.

Edwards, Steve, “Rethinking the 60/40 Portfolio,” August 30, 2022 Wealth Management, Morgan Stanley, https://www.morganstanley.com/articles/60-40-balanced-portfolio-rethinking-strategies.

Jones, Brian, and Anton Kwang, Steve S. Shigekawa, “REITS and Rates,” May 2021, Neuberger Berman, https://www.nb.com/en/global/insights/insights-reits-and-rates.

A REIT is a security that sells like a stock on the major exchanges and invests in real estate directly, either through properties or mortgages. REITs receive special tax considerations and typically offer investors high yields, as well as a highly liquid method of investing in real estate. There are risks associated with these types of investments and include but are not limited to the following: Typically no secondary market exists for the security listed above. Potential difficulty discerning between routine interest payments and principal repayment. Redemption price of a REIT may be worth more or less than the original price paid. Value of the shares in the trust will fluctuate with the portfolio of underlying real estate. Involves risks such as refinancing in the real estate industry, interest rates, availability of mortgage funds, operating expenses, cost of insurance, lease terminations, potential economic and regulatory changes. This is neither an offer to sell nor a solicitation or an offer to buy the securities described herein. The offering is made only by the Prospectus.

Mutual Funds and Exchange Traded Funds (ETF’s) are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from the Fund Company or your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.

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