What does rising Inflation mean? What it could mean to your Portfolio?
According to International Monetary Fund, inflation is the rate of increase in prices over a period. It also reflects the diminishing purchasing power of currency over time. In July 2021, according to the Labour Bureau of Statistics, the Consumer Price Index (CPI) was 5.4; it means that the overall prices have gone up by 5.4% over the last 12 months. Inflation influences every aspect of the economy. It would influence producers, suppliers, consumers, policymakers, banks, and investors.
Influence of Inflation on Investment Portfolios
All investors would like to earn higher inflation-adjusted returns from their portfolio of assets. For instance, an annual return on investment (ROI) of 10% doesn’t look great if the inflation in that year is 9%. A 7% ROI from the portfolio is good in an economy where inflation is just 2%. Wealth management firms Los Angeles aim to create and manage portfolios that produce handsome inflation-adjusted returns.
Investment portfolios lose value when hyperinflation strikes the economy. It arises when the prices of goods and services grow beyond control within a short period. Typically, hyperinflation occurs when prices increase by 50% every month over time. Though hyperinflation is a rare phenomenon in actively managed economies like the United States, the United Kingdom, Canada, and Germany, investors need to prepare for the worst by creating high-inflation-proof investment portfolios.
In our last blog, we mentioned two specific periods in history that stand out when looking at a benchmark for the dangers of inflation. Historically, two scenarios have caused hyperinflation, they are:
- The Post World War One Weimar Republic Germany
- The Great Inflation in the 1970s
Post World War One, the hyperinflation struck German economy. Germany’s currency went from 90 marks per dollar in 1921 to 4,210,500,000,000 marks in November 1923.
Inflation rose from 4% in 1972 to 14% in 1980. A few factors including, central bank policies, Keynesian policies, and abandonment of the gold window resulted in the Great Inflation in the 1970s. Unfortunately, none of these factors are in the control of individual investors. The stock market went down by 50% in 20 months and eroded a lot of investor’s wealth in the 1970s.
A Bullet-proof Portfolio
Investors cannot control the influence of macroeconomic factors like inflation, interest rates, unemployment rates on their portfolios. All they can do is to create a bulletproof portfolio that survives the impacts of macroeconomic factors. A bulletproof portfolio allocates funds to different classes of assets rather than sticking to individual stocks. It comprises assets like real estate, mutual funds, individual stocks, exchange-traded funds (ETFs), bonds, Treasury Inflation-Protected Securities (TIPS), and mortgage-backed securities.
An example of fund allocation in a “bulletproof” portfolio may be:
- 35% to Individual stocks and ETFs (large caps and midcaps)
- 20% to real estate or REITs
- 12.5% to hybrid fixed-income assets
- 10% to commodities including Gold
- 10% to TIPs and corporate bonds
- 5% to retirement savings account like 401(K)
- The rest is in cash.
Not every asset management firm in Los Angeles has the knowledge and expertise in building bulletproof portfolios that sustain economic recessions, inflation, and other macroeconomic factors. Upon analyzing an investor’s risk appetite, investment goals, and time horizon, a wealth management partner may come up with a suitable portfolio that generates handsome returns in a volatile economic environment.
We encourage you you, as an investor, to reach out and talk to a several financial professionals and decide which is right for you.
