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To ensure that investments perform well, special considerations need to be taken. Each element in a well-diversified portfolio will have a unique tolerance for inflationary times.
When it comes to stocks, companies whose products are always in demand are best-positioned to perform well in light of inflation. In general, inflation raises the price of consumer goods. As prices rise, consumers may forgo luxury items like electronics and jewelry, but continue to buy staples, such as toilet paper and milk.
Any increases in consumer staple production costs that would negatively affect such businesses typically can be passed on to the customer by raising prices. As a result, the consumer staple sector, which includes brands selling food, drugs, hygiene products and basic household products, generally performs better than average in a market affected by inflation.
Other stocks that do well in times of inflation are those that are considered “capital light” or “asset light” businesses. Retail businesses that are thought of as “capital heavy” businesses, primarily because they need to maintain high inventories to operate, tend to struggle. Tech companies, especially those that deal exclusively in software, are considered capital light businesses. Google, Facebook and Microsoft are good examples.
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Real assets, such as real estate and commodities, typically perform better than stocks during inflationary times. Investments in real estate, whether through actual properties or real estate investment trusts, benefit from the rise in costs of consumer goods, which affect the cost of new home construction. As houses become more expensive to build, new home prices increase, prompting a corresponding rise in existing home prices. Those priced out of the real estate market are forced to rent, which drives up the rates for rental properties.
Commodities, which include agricultural goods, metals and biofuels, serve as hedges against inflation because they typically increase in value as demand rises and supply tightens. We’ve already seen energy prices, including oil, natural gas and coal, surge to
While most bonds lose value during times of inflation, there are some that should be considered. U.S. Treasury Inflation-Protected Securities (TIPS) provide interest payments based on rates that rise with the inflation rate. When TIPS mature, investors receive either the original principal or the principal as adjusted by inflation, whichever is greater. Those investing in TIPS should be aware that they require special tax
Alternative investments have come to be seen by some as a way to gain stability during inflationary periods as their values are not affected by the same indicators as those that affect stocks and other more common investment products. These alternate investments include fine art, antiques, wine and gems. While cryptocurrency is considered an alternative, its relatively recent introduction as an investment vehicle provides little data to establish how it performs during times of inflation.
While evaluating portfolios in light of inflation can be valuable and may reveal obvious opportunities to either realize unexpected gains or avoid unnecessary setbacks, advisors should not let a period of short-term inflation distract them from the long-term goals of clients' investment plans.
It’s important to note that many of the positions considered hedges against inflation require a long-term commitment, which may run counter to your investment strategy. Staying focused on time frames and long-range goals could keep portfolios on track to achieve clients' investment objectives.
