While you may enjoy more of a financial buffer compared to others, inflation can still throw a wrench into your short-term plans. We ask the question “how does inflation affect investments?” and take look at what inflation means to business growth, how you can avoid the impact of inflation on your investments and assess some smart strategies to stay ahead of the curve.
What is Inflation?
As a simple definition of inflation, you could say it is a measurement of a rise in the general price of goods and services. As prices rise, this erodes the purchasing power of cash and certain investments.
For people with a high net worth, it has an immediate impact.
Influence of Inflation
Reduced Buying Power – Increased Cost of Living
Say you’ve got a $100,000 investment earning 2% interest annually, as inflation hits 5% inflation, your real return goes negative (-3%). Not only does your earning power go down, but everything – including travel and luxury goods – sees a price hike. So, your money also buys less, impacting any day-to-day expenses and planned purchases. This could put a strain on your discretionary spending and may even force adjustments to your lifestyle.
Investment Strategies to Mitigate Inflation
You probably have a wider array of investment options to hedge against inflation than most. Here are some key strategies that you could:
Real Assets: If you invest in assets whose value tends to rise with inflation – like real estate (land, rental properties), commodities (precious metals, oil), and infrastructure (toll roads, utilities) you may be able to outpace inflation as their prices rise faster. Commodities like gold are ‘inflation hedges’ – their demand tends to increase during periods of economic uncertainty.
Stocks with Inflation-Beating Potential: Not all stocks are created equal. You’ll need to look for companies with strong pricing power – meaning they can raise prices to maintain their profit margins despite inflation. These are often established companies in essential sectors like consumer staples (food, beverages), healthcare, and utilities.
Inflation-Protected Securities (TIPS): These government bonds see their principal value adjust based on inflation, ensuring investors receive their purchasing power back at maturity. While the interest rates may be lower than traditional bonds, they provide a guaranteed inflation hedge.
Diversification is Key
Don’t put all your eggs in one basket! Investing in well-managed, diversified portfolios helps mitigate risk and capture potential gains from different sectors. Our range of investment types span across property, alternatives & more.
How does inflation affect investments?
We explore both the short and long term effects:
Short-Term Adjustments
Smart investment strategies are crucial, but you might also want to adapt some spending habits to navigate the effects of inflation:
Review Expenses: Look at your recurring costs and identify areas for potential cuts. Consider renegotiating or fixing financial arrangements, look for savings, and reduce any non-essential spending.
Prepay for Future Needs: If you know a large expense is coming up – new car purchase, substantial home renovation – you should act now. Prepaying with currently available funds will avoid the inflated cost later.
Focus on Cash Flow: Short-term investments with high liquidity can be helpful to cover immediate expenses or take advantage of sudden investment opportunities.
Seek Professional Advice: Trusted financial advisors give you far more personalised strategies based on your individual circumstances and risk tolerance.
Long-Term Considerations
Inflationary periods tend to be cyclical. While the short-term impact needs attention, you are going to need to look at long-term wealth preservation too:
Focus on Growth Assets: Investments in high-potential growth businesses – particularly those with a history of substantial dividend growth, can provide a hedge against inflation while offering the potential for significant returns over an extended period.
Maintain a Diversified Portfolio: Now is a good time to rebalance your portfolio to maintain the desired asset allocation and ensure long-term growth prospects. Remember, inflation is a marathon, not a sprint. By having a well-defined strategy, you can navigate the short-term challenges and ensure their wealth continues to grow over the long term. Learn more about what diversification in investing is here.
Additional Considerations
Watch out for taxes: Inflation can push individuals into higher tax brackets, and you may need expert financial advice to minimise your tax burden.
Global Diversification: Investing in companies and assets in different countries can offer diversification benefits and mitigate the impact of inflation specific to one region.
Alternative Investments: Explore alternative asset classes like private equity, venture capital, or hedge funds. With the right professional guidance, these can offer higher potential returns.
Inflationary periods demand action. With the right advice, and by understanding how inflation affects your finances, you will be able to implement a combination of investment strategies and spending adaptations, that not only maintain your lifestyle and purchasing power but also position your wealth for very sustainable growth as the inflationary cycle becomes more typical. If you would like to speak with an experienced financial advisor, please contact us at MHG Wealth Management today.
