How Will Inflation Affect My Portfolio?

The Consumer Price Index has recently soared to a 40 year high with no signs of slowing down. CPI is a benchmark that is used to track the pricing changes in a group of goods and services such as food, transportation, and medical care. Inflation is often looked at as a bad thing, however the Federal Reserve typically aims to keep inflation at 2% rather than 0% in order to keep a stable economy. Keeping the inflation rate too low could increase unemployment as well as lower the overall gross domestic product in the long run. However, keeping inflation as high as it is currently can result in soaring prices that the economy can not sustain.

Current high inflation rates can mostly be explained by government stimulus, pandemic induced supply chain lockups, and the Russian-Ukraine war. While elevated inflation levels will likely be a problem for some time, the worst of the issues may be behind us as supply chains start to restore themselves and the Federal Reserve begins raising interest rates.

Federal Reserve Chairman Jerome Powell has stated that he would like to raise rates a total of seven times in 2022, which should help bring inflation down towards more normal levels. Changing rates too quickly in either direction can cause a shock to the economy, so the Federal Reserve has opted to do multiple rate hikes, expected to be around 25 basis points each.

With high inflation likely to linger for at least a little while longer, it is important to be aware of how this might impact you.

Inflation is concerning for a variety of reasons. At the gas pump to the aisles at the grocery store, it can be felt pretty much everywhere. But inflation can also play a role in your retirement accounts.

Looking at the last 30 years, we can see that there is little correlation between inflation and market performance in any given year. In fact, the lowest returns seen here are when inflation is also at its lowest. This isn’t to say that high inflation is good, it isn’t. But it’s important to realize that inflation alone does not play a significant role in the market cycle.

Different asset classes do perform better or worse in periods of high inflation. Generally things like real estate (REITs), utilities, precious metals (gold) and consumer staples all tend to outperform in these periods. However, it is impossible to know just how long these periods will last, and how severe they might be. Tilting your portfolio slightly can have its advantages and disadvantages, but it’s never smart to put all of your eggs in one basket. Systematically investing in a globally diversified portfolio of stocks, bonds, commodities, real estate and other non-correlated assets, is still the best way to protect your portfolio.

With the Federal Reserve raising rates, variable interest rates will rise with it. The federal funds rate impacts various interest rates such as mortgages, credit cards, HELOC’s and savings accounts. If you are carrying any debt or plan on taking on more debt, it will be important to monitor the increased cost associated with rising interest rates.

Rates for 30-Year fixed rate mortgages bottomed at 2.66% in late 2020 and have gone up over 1.5% in 2022 alone, so far. Home equity lines of credit are tied to the prime rate, currently 3.5%, which is associated with the federal funds rate. As debt becomes more expensive, it might be a good idea to reevaluate your debt repayment strategy.

Every investor has varying levels of risk tolerance and risk capacity. It’s impossible to predict exactly how the market will react to inflation and interest rates going forward. Traders in the futures markets have already bet on multiple rate hikes this year. There will always be a certain level of uncertainty and uneasiness in the market which is why it’s crucial to match your portfolio with your risk tolerance and your risk capacity.

If you have any questions or concerns regarding inflation, interest rates, or your portfolio please reach out to us at 330-562-2122 or via our Contact Us page.