How to invest for inflationary times
By Chris Taylor
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[February 03, 2022] NEW
YORK (Reuters) - Low inflation had spoiled U.S. investors for so long
that last year's sudden surge came as a shock.
As those who lived through the late 1970s and early 1980s can attest,
inflation can be a "portfolio killer" because it erodes purchasing
power.
Inflation revved up to 7% in December compared to the year prior, the
highest level in decades.
Even at 3% annual inflation, in 20 years you would need $181 to match
what $100 buys today, according to the calculator at fintech site
SmartAsset.
How does that change the money or asset mix you need for retirement?
"Many investors have never experienced inflation like we have seen the
last few months, so it may be a good time to revisit your portfolio and
confirm whether you still feel confident," said Naveen Malwal, an
institutional portfolio manager at Boston-based financial giant Fidelity
Investments.
After all, some asset classes tend to perform better during
higher-inflation periods. Among 15 major asset classes in inflationary
periods since 2000, the top performers included oil (41% return),
followed by emerging markets stocks (18%), gold (16%), and cyclical
stocks (16%), according to a Wells Fargo study.
On the flip side were a couple of bond categories. Emerging markets
fixed income lagged with -8% return, while investment-grade fixed income
returned -5%.
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Economists generally agree that inflation will back off from current
overheated levels. Over the next 10 years, they expect the Consumer
Price Index to average a modest 2.55% annually, according to the Survey
of Professional Forecasters from the Federal Reserve Bank of
Philadelphia.
"Look at the things driving inflation: There is too much money chasing
too few goods," said Scott Wren, senior global market strategist for
Wells Fargo Investment Institute.
"There is money supply growth, there are transfer payments which
increased savings, there is supply chain disruption. By the end of the
year, we should see some easing, and all those things will help the
inflation story."
Which investment areas should benefit from rising prices, and which will
not? Here is what the experts say:
ESCHEW CASH
During inflationary periods, the value of your cash holdings will erode
over time, perhaps substantially so.
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People count money at Macy's Herald Square store during the early
opening of the Black Friday sales in the Manhattan borough of New
York, November 26, 2015. REUTERS/Andrew Kelly
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"Investors are sitting on way more cash than they should," Wren said.
With indexes like the Nasdaq touching correction territory, now may be a good
time to start putting that cash to use, and accumulate harder assets that should
hold up during periods of higher inflation.
TIPS ARE YOUR FRIENDS
Fixed income markets tend to get hit hard by inflation. A bond paying out a
rock-bottom yield for an extended period is a poor option when prices and
interest rates are rising.
One corner of the bond market has the answer: Treasury Inflation-Protected
Securities (TIPS), whose principal increases with inflation and throws off
interest twice a year at a fixed rate.
"That's one way to stay invested in the bond market, and they are literally
designed to provide you inflation protection," Malwal said.
LOOK AT HISTORY
Investing has no guarantees, but past performance during inflationary periods
can provide some clues.
"In higher-inflation environments, things like commodities do well," said Wells
Fargo's Wren. "So do mid-cap and small-cap stocks. The energy sector typically
does well, and equity REITs (real estate investment trusts). I also think
financials, industrials, and materials will all benefit."
DO NOT OVERREACT
Just because inflation is uncomfortably high, do not expect that to last
forever. Minor portfolio tweaks may be in order, but wholesale changes are
probably a mistake.
Forecasters see inflation drifting down over 2022 as supply chain problems ease
up, labor markets normalize, and COVID-related emergency cash infusions recede.
"Most people agree we're headed lower. The question is how much lower and how
long will it take to get there,” said Fidelity's Malwal. "It could be closer to
3-4% by the end of the year."
(Editing by Lauren Young and Richard Chang.)
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