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,
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.
How does inflation affect investments?
In the long run, low to moderate
Inflation & stocks
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
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.
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Inflation & bonds
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.
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Inflation and TIPS
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 and real estate
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
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.
Why are people with savings hurt by inflation?
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.
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How to protect your investments against inflation
One way to approach
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:
- Real estate
- Value stocks
- Series I bonds
Examples of investments to potentially avoid during high inflation include:
- Growth stocks
- Long-term bonds
The bottom line
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