Carol Clark, CFA
Numerous studies have shown that strong financial health has a direct impact on our wellbeing. Having security and peace of mind about our financial situation plays a vital role in our overall physical health and happiness. The markets are changing. Over the past 10 years, the annual inflation rate in the US has averaged 1.88%. In 2022, however, we saw inflation spike to 9%. Inflation can have a significant impact on the value of your investment portfolio. When the general price level of goods and services rises, the purchasing power of your money decreases, and you will end up with less real wealth.
Low levels of inflation are healthy for the economy and financial markets. History has shown that a modest level of inflation leads to positive economic growth and rising profits, both of which have a favorable impact on markets. But too much inflation has a negative impact on consumers which in turn depresses the economy. This is why the Federal Reserve took aggressive steps to curb inflation last year with a series of large, rapid rate increases. But with unemployment at historic lows, inflation has proven to be quite sticky.
Many believe it will be difficult for the country to ever return to the low, stable inflation we grew accustomed to over the past three decades. If elevated levels of inflation persist, the need to have an inflation-protected portfolio is imperative. Savvy investors will want to take steps now to insulate their portfolio from the corrosive impact inflation will have on future purchasing power. People often underestimate the punishing effects of inflation. Even if inflation is only 2% per year, $100,000 today would be worth only $67,000 in 20 years.
Market conditions are truly changing. Bond yields have increased dramatically. With the return on Treasury bonds at a 15 year high, we have one of the hottest bond markets in memory. You can now buy short-term Treasury bonds, which are considered a risk-free asset, yielding more than 5%. These bonds are an attractive addition to a balanced portfolio. Focusing on high-quality, short-term bonds, preferably individual bonds, will offer the most defensive protection especially if a recession is on the horizon. But 5% bond returns alone will not be enough to keep you ahead of the silent, ravaging effects of inflation. If your portfolio is too conservative, you simply cannot keep pace which is why having the right strategic complement of inflation-resistant investments is so important. As Warren Buffett, Chairman & CEO of Berkshire Hathaway, likes to point out, bond returns alone will not do the trick. To maintain financial wellbeing and achieve financial success, you will need an appropriate level of equity exposure to avoid falling behind. Your aim is to generate investment returns that exceed the rate of inflation so that you not only keep pace but can realize improvements in lifestyle.
This goal underscores the importance of building a resilient portfolio: one which includes assets that appreciate in value during inflationary times. It must have the right mix of stocks and bonds as well as the correct emphasis on inflation-resistant sectors such as consumer staples and healthcare. Dividend paying stocks also bring attractive protection to a portfolio. Dividends provide a steady stream of income and, unlike the interest on a bond, generally increase over time providing an important added inflation hedge. Stocks of large, high quality, profitable companies that have pricing power are another good choice. These companies can increase the prices of their goods and services in response to inflation, which can help protect their profitability and stock value. One advisable tactic is to look for companies that have a strong competitive position in their industry, a loyal customer base, and a strong brand.
In summary, inflation can be a significant threat to your investment portfolio, but there are protective steps that can be taken. Investing in assets that perform well in inflationary times can help safeguard your wealth and protect your purchasing power over time.
At OnCenter, we focus exclusively on identifying diverse opportunities that optimize returns and minimize fees and taxes to create lasting family wealth. Unlike many financial advisory firms which profit by taking a cut from every investment offered, OnCenter offers true independent fiduciary services meaning that we are legally bound to act only in the client’s best financial interest. Utilizing our advanced investment training to help others achieve financial success is the cornerstone of our personal mission.
If you would like to learn how the OnCenter team can enrich your financial future, contact us for a complimentary initial consultation.
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