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Inflation rose more in June than it has in more than 10 years, and this news is worrying investors.
This is because rising prices can erode a portfolio’s earnings. Put simply, as the cost of living increases, your returns don’t go that far.
This is a particularly difficult challenge for retirees, who can rely primarily on the returns on their investments to pay their bills, while the younger ones still have a salary. And then there’s the fact that inflation can cause the Federal Reserve to raise interest rates, which tends to be bad for stocks.
“In general, inflation is generally negative for stocks,” said Amy Arnott, portfolio strategist at Morningstar.
She recalled the story: between 1973 and 1981, inflation increased by more than 9% per year. During the same period, stocks lost about 4% per year.
But don’t panic, it has never helped an investor.
First of all, we still don’t know if the price hike will become the new normal or if it’s just a temporary result of a nation emerging from a pandemic and a year of lockdowns and restrictions.
Either way, history shows that stocks beat inflation in the long run.
The average annual return on stocks was around 11% between 1900 and 2017, according to calculations by Steve Hanke, professor of applied economics at Johns Hopkins University in Baltimore.
After subtracting the cost of inflation, this average annual return remains a handsome 8%.
Still, there are steps investors can take to protect their money from inflation – and even take advantage of the environment, financial advisers say.
How to profit from the price increase
Alex Doll, a certified financial planner and president of Anfield Wealth Management in Cleveland, recently reduced his clients’ exposure to growth stocks. And he increased their allocation to value stocks, or companies that trade at rates below the S&P 500 average.
“Value stocks can do a little better during times of inflation,” Doll said.
That’s because these companies are often in industries, such as finance and consumer staples, that are less hit by inflation, Doll said: “These industries tend to perform better because that they have more pricing power and inflation better than other industries.
These companies are also usually already well established, he said, so you don’t have to worry as much about losing value as they are expected to grow.
Another good match for inflation-worried investors are Inflation-Protected Treasury Securities, or TIPS, said CFP Nicholas Scheibner, wealth management advisor at Baron Financial Group in Fair Lawn, New Jersey.
These securities carry similar risk to other fixed income investments, he said, but they add an adjusted principal amount if inflation rises.
Other inflation hedges include investing in real estate, gold and even cryptocurrencies, according to the advisers.
“Real estate works well because homeowners and homeowners are seeing the value of their properties increase,” Doll said. “Plus, landlords can pass rent increases quite easily.”
The argument for investing in cryptocurrencies or gold in the midst of inflation is that these assets are not damaged by the erosion of the value of money.
However, both are highly volatile and should not represent more than 5% of your portfolio, experts warn.
Investments to avoid in times of inflation
Because a Fed interest rate hike could be in store, experts recommend not to tie too much money now in long-term bonds or certificates of deposit. This could cause you to miss out on higher rates later.
“I currently advise clients to focus on short and medium term bonds and avoid any investments with a long term name,” said Doug Bellfy, CFP at Synergy Financial Planning in South Glastonbury, Connecticut.
Another area you might want to avoid is in growth stocks or companies with above-average expected earnings, Doll said.
“Growth stocks tend to perform less well because they expect to earn most of their cash flow in the future,” Doll said. “And as inflation rises, those future cash flows are worth less.”