How does inflation affect investments?

After several months of high inflation, you might be feeling like you've been pushed off track financially. And you're not the only one. In 2022, inflation reached 9.1%, which marked its highest point in 40 years. Because inflation shrinks consumers' purchasing power, it also affects the economy and nearly every aspect of personal finance. This can be incredibly challenging to experience.

Thankfully, there are some things you can control. By taking a fresh look at your finances and learning how inflation affects investments, you can get a better idea about what kind of investment choices might help you protect against inflation. Although high inflation won't last forever, and investments are a long-term strategy, diversifying your portfolio and strengthening your household finances can be wise in any environment.

Let's look at inflation and what kind of influence it can have on different investments, so you have the information you need to make wise financial decisions.

In the long run, low to moderate inflation is normal and the prices of investment assets can rise along with goods and services. However, an environment of high inflation generally has a negative effect on many investments, such as stocks and bonds, but can be positive for other investments, such as certain Treasury securities and real estate.

While stocks are generally good investments for fighting inflation over time, high inflation can negatively affect stocks. For this reason, stock prices tend to be volatile during periods of high inflation.

Stock market volatility during inflation can occur because stock prices are largely based on investor expectations of companies' future earnings, and extreme inflation can make it difficult to accurately gauge company valuations. For example, companies with high levels of debt may be worse off during inflation because higher borrowing costs can reduce their bottom line profit.

In the first half of 2022, the stock market, as measured by the S&P 500 index, fell by more than 20%, which officially made it a "bear" market. However, growth stocks, as measured by NASDAQ 100 index, fell by more than 30%.

Businesses with stronger cash flow situations can sometimes fare better during inflation. Because of this, growth stocks tend to suffer more than value stocks during inflation.

> Read more: How does inflation affect stocks?

Since higher interest rates generally accompany higher inflation, an inflationary environment can have a negative effect on fixed-income securities, such as bonds and mutual funds invested in bonds. This is because bond prices tend to move in the opposite direction of interest rates.

Some bonds and bond funds are affected more than others during periods of high inflation and rising interest rates. Typically, the longer the duration of the bond, the greater the interest rate sensitivity. Therefore, long-term bonds and bond mutual funds will generally suffer greater price declines than short-term bonds during high inflation.

> Read more: Bonds & inflation: What you need to know

Treasury inflation-protected securities (TIPS) can be a good investment choice during high inflation. These particular Treasury bonds are linked to the consumer price index, which means they adjust payments upward when inflation rises, while other types of bonds don't. Keep in mind, however, that falling inflation can have the opposite effect and reduce the value of TIPS.

Inflation affects real estate primarily because of rising interest rates, which often accompany periods of high relative inflation. When interest rates are rising, the prices for some asset classes, such as certain stocks and bonds, tend to fall. However, real estate is an asset class that can perform relatively well during inflationary, rising-rate environments.

Areas of real estate that can perform well during inflation include income-generating residential and industrial real estate sectors. Growth in these areas can outpace inflation because of the ability to raise rents and from growing demand.

People with low-interest savings accounts, money market funds and certificates of deposit (CDs) can be hurt by inflation because it cuts purchasing power. More specifically, if the interest rate for your savings account is lower than the rate of inflation, you are effectively losing money over time.

Furthermore, higher inflation may translate to lower savings rates or cause more people to draw from their savings accounts to keep up with the rising costs of goods and services.

> Get more tips: Inflation's effect on savings: How it works & ways to offset it

One way to approach investing during inflation is to diversify your portfolio.* Through diversification, you potentially can reduce market risk by spreading your money across different asset types. For example, you can increase exposure to investment assets, such as TIPS and real estate, which can be good inflation hedges.

You may also reduce exposure to other investments, such as growth stocks and long-term bonds, which typically do not perform well during periods of high inflation.

Examples of potential inflation hedges include:

• TIPS
• Real estate
• Value stocks
• Gold
• Series I bonds

Examples of investments to potentially avoid during high inflation include:

• Growth stocks
• Long-term bonds

Inflation is normal in any economy. However, high inflation significantly shrinks the purchasing power of consumers and businesses, which can negatively impact the economy and your household's finances. It's not a reason to panic, but it can prompt you to reexamine and adjust your investment portfolio.

You don't need to figure all of this out alone. Talking to a trusted financial professional can help you confront your emotions and feel more confident about your money during uncertain times. Knowing how inflation affects investments can help you know what influence it may have on your financial strategy. With the help of a local Thrivent financial advisor, you can learn which inflation hedges are right for you, chart a clear path forward and stay focused on your goals.