A pandemic, mismatches between the supply and demand of goods, and disruptions to the global supply chain all have been cited as reasons for rising inflation rates.
“The world is just beginning to emerge from an unprecedented shock to financial markets and our personal lives,” says Steven Saunders, director and portfolio advisor with Round Table Wealth Management in Westfield, New Jersey.
As a result, inflation rates have risen, and today’s higher prices reflect that trend.
Now, after months of uncertainty, the question remains, “What’s ahead?” When it comes to inflation rates and investments, the dilemma can be worrisome, especially for those looking for ways to build wealth over the long term.
Before making financial decisions, it can be helpful to understand the relationship between inflation and different types of investments. Consider the following ways that inflation can affect properties, bonds, stocks, and precious metals as you evaluate your portfolio and its performance.
Inflation and Properties
“During high inflation, we tend to see rent increases,” says Juan Marin, a real estate broker and investor at IBR Group Corp in Orlando, Florida. As interest rates rise as well, it can be difficult for those renting to get a mortgage and move into their own home. As such, many renters may opt to stay where they are and pay a higher price from month to month.
Given these trends, if you own rental property, such as residential, commercial, multi-unit, or single-family homes, you may see higher than normal demand and returns as a result of high inflation.
Another area that might bring higher returns involves real estate investment trusts (REITs), which are companies that own or finance real estate properties. They invest in a variety of property segments and typically focus on income-generating properties.
“REITs will follow the market demands and appreciation similar to that of physical real estate,” Marin says. As such, REITs may provide a way to distribute your investment across numerous assets.
However, other forms of real estate investing, such as vacation rentals, might not perform as well.
“When prices rise and pockets get tight, travel tends to be reduced from the yearly budget,” Marin says.
Inflation and Bonds
“Currently, a portfolio of just Treasury bonds and cash does not provide the required return to compensate for inflation,” Saunders says. The reason for this is two-fold. Firstly, the dollars you have today will lose value over time. If you have $100 cash and the inflation rate is 5 percent, that $100 will be able to purchase $95 worth of goods and services after a year.
As this trend continues, the money’s purchasing power will continue to decline. Second, bonds with fixed returns that are lower than inflation rates could put you at a loss. The return you receive may be less than the rate by which goods and services are increasing.
“Investors may be quick to buy TIPS (Treasury Inflation-Protected Securities) if they fear inflation is going to increase,” Saunders says. As the name suggests, these investment vehicles are adjusted for inflation. That said, the adjusted portion is only part of the return. The other portion is called “real yield,” which is the yield on a nominal Treasury bond, minus the expected inflation.
“TIPS outperform nominal bonds when the real yield is declining, meaning inflation expectations are increasing faster than nominal rates in a rate rising environment,” Saunders says. “However, if nominal yields increase at a faster pace than inflation expectations, a TIPS investor can actually lose money as real yields rise.”
Inflation and Stocks
The S&P 500, which began in the 1920s, has averaged around a 10 percent return.
“Since the average U.S. inflation rate is around 2.25 percent, you can see how putting your money in the market should earn you more than the annual average,” says Joseph Gissy, founder and CEO of Strategy Marketplace in Mundelein, Illinois. “However, an average doesn’t always work in all cases.”
For instance, “we could end up in a period where the S&P 500 hits a period of a bear market because when inflation is typically high, then the markets can tumble,” Gissy says. If that happens, the S&P could stumble and have trouble providing a return that keeps up with inflation. Some stocks might perform better than others during periods of inflation, as many factors weigh into a company’s current and forecasted performance. As such, investing in stocks during periods of inflation may need additional research and call for decisions to be made on an individual basis.
Inflation and Precious Metals
“If you’re looking to outpace inflation rates, it could be worth investing a portion of your savings in precious metals like gold or silver,” says Maxim Manturov, head of investment research at Freedom Finance Europe. You might also consider precious metals exchange-traded funds (ETFs), which consist of various securities that are bundled and traded together on a stock exchange like a regular stock.
“Assets like precious metals are great safe havens for your finances because their value generally appreciates to account for inflation—making it a relatively safe way of avoiding depreciation on the savings that you’re making,” he says.
Rachel Hartman is a freelance writer with a background in business and finance. Her work has appeared in national and international publications for more than 10 years. She resides in Miami and travels frequently.