How does inflation affect my investments?
What is inflation?
Inflation is an economic phenomenon that refers to a sustained increase in the general price level of goods and services in an economy over a period of time. This means that, as inflation increases, each unit of currency buys fewer goods and services; consequently, inflation erodes the purchasing power of money.
Inflation is typically measured by comparing the prices of a basket of goods and services over time. This basket is known as the "consumer price index" (CPI) and is used to calculate the rate of inflation. For example, if the CPI was 100 in a given year and 110 the following year, the inflation rate would be 10% (110/100 - 1).
Inflation is caused by a variety of factors, including increased demand for goods and services, rising production costs, and changes in the money supply. It can have a number of impacts on an economy, including redistributing wealth, affecting the value of money, and influencing interest rates and borrowing costs.
What causes inflation?
Inflation is caused by a variety of factors, and the specific causes of inflation can vary depending on the specific circumstances of an economy. Some of the most common causes of inflation include:
Increased demand: If the demand for goods and services increases faster than the supply, this can lead to higher prices and inflation. For example, if more people are working and earning higher incomes, they may be willing to pay more for goods and services, which can cause prices to rise.
Rising production costs: If the costs of producing goods and services increase, this can also lead to higher prices and inflation. For example, if the cost of raw materials or labor increases, businesses may need to raise prices to maintain their profit margins.
Monetary factors: Changes in the money supply can also affect the rate of inflation. For example, if the central bank increases the money supply faster than the economy is growing, this can lead to more money chasing the same amount of goods and services, which can drive up prices.
Overall, there are many factors that can cause inflation, and the specific causes can vary depending on the economic circumstances of a given country or region.
How does inflation affect my investments?
Inflation can have a number of effects on investments, and the specific impact will depend on the type of investment and the rate of inflation. Some of the ways that inflation can affect investments include:
Real returns: Inflation can reduce the purchasing power of money, which means that investments that do not keep pace with inflation can lose value in real terms. For example, if an investment has a return of 3% and the rate of inflation is 4%, the investment would have a negative real return of -1% (-3 + 4 = 1).
Interest rates: Inflation can also affect the interest rates that investors receive on their investments. If the rate of inflation is high, investors may require a higher rate of return to compensate for the loss of purchasing power. This can make it more difficult for investors to find attractive investment opportunities, and can lead to lower returns on investments such as bonds.
Equity investments: Inflation can also affect the value of equity investments, such as stocks. Inflation can lead to higher costs for companies, which can reduce their profits and potentially their stock prices. However, some companies may be able to pass on higher costs to consumers, which can protect their profits and potentially their stock prices.
Overall, inflation can have a number of effects on investments, and it is important for investors to consider the potential impact of inflation on their investment portfolio.
How can a financial planner help protect you against inflation?
A financial advisor can help to position a portfolio to protect against inflation in a number of ways. Some of the strategies that a financial advisor may recommend include:
Avoid holding too much cash
Everyone needs to have some money in savings accounts to pay for everyday expenses, save for emergencies and plan for large purchases.
However, as a long-term investment, cash is not where you want to be, especially when the economy is experiencing high levels of inflation.
As inflation takes its toll, you’re able to purchase fewer goods and services each year with your cash.
If you’re holding more cash than you need, consider investing some of it in long term investments that are more likely to maintain your purchasing power over time. Experts suggest holding about 3 to 6 months worth of expenses in an emergency fund, but if you have more than that saved, in the long term, you may likely be better off if you invest it.
Re-evaluate your portfolio
This is an opportune time to revisit your portfolio and asset allocation with your Newcastle Financial Planner to see if they still meet your desired rate of return and risk tolerance. A couple things to keep in mind related to stocks and bonds in a higher inflationary environment:
Stocks offer higher potential returns, which can help your portfolio outpace the rate of inflation, but stocks also tend to be more volatile than conservative investments like bonds.
Bond prices maintain an inverse relationship with interest rates. One of the Federal Reserve‘s tools to combat rising inflation is raising interest rates, and when interest rates rise, bond prices typically decrease. As a result, you may want to avoid overexposure to bonds, which may tumble in value during a rising-rate environment.
Explore physical assets
Real estate investments tend to do well during inflationary environments because, as inflation rises, landlords are able to pass those higher costs on to their tenants. However, within Australia we have other factors that are affecting the property market which need to be taken into consideration.
Other real assets to consider include infrastructure where agreements for airports, toll roads, ports, water and electricity have revenue linked to inflation.
Consider commodities
While stocks and bonds tend to perform better when inflation is low, commodity prices tend to rise with inflation. For that reason, investing in commodities can be an appealing hedge against inflation.
Look into inflation linked investments
There are investment products that are designed so that their principal value is indexed to the rate of inflation. When inflation rises, the value of the principal is adjusted up and the interest rate, or coupon, also rises. When inflation falls, principal value is adjusted down and coupon payments will decline as well.
Revisit your budget
Inflation can be particularly hard on investors who are nearing, or who have just entered, retirement. Drawing down your investments faster than planned at the beginning of retirement can have long lasting-effects on your savings for years to come. To help avoid this, look for areas in your budget where you can cut some discretionary expenses, at least in the short-term. Putting off that trip to Europe or caravan trip around Australia for a year or two could pay dividends for you down the road.
Overall, a Newcastle financial planning adviser can provide valuable guidance and expertise when it comes to protecting a portfolio against inflation. By working with a Newcastle financial planner, investors can develop a strategy that is tailored to their individual circumstances and goals.
What are the affects inflation has on retirement?
Inflation can have a number of effects on retirement, and the specific impact will depend on a person's individual circumstances and the rate of inflation. Some of the ways that inflation can affect retirement include:
Reduced purchasing power: Inflation can reduce the purchasing power of money, which means that the same amount of money will be able to buy fewer goods and services in the future. This can make it more difficult for retirees to maintain their desired standard of living if their savings do not keep pace with inflation.
Higher cost of living: As prices rise due to inflation, the cost of living in retirement can also increase. This can include expenses such as housing, food, healthcare, and other necessities. Retirees may need to find ways to reduce their spending or find additional sources of income to maintain their standard of living.
Higher retirement savings goals: Inflation can also affect how much money is needed to save for retirement. As the cost of living increases due to inflation, retirees may need to save more money to be able to maintain their desired standard of living in retirement.
Overall, inflation can have a number of effects on retirement, and it is important for people to consider the potential impact of inflation on their retirement plans. This can include planning for higher costs of living and saving enough money to maintain their desired standard of living in retirement.
Why see a financial planner about inflation?
It is a good idea to see a Newcastle financial planner about inflation for a number of reasons. Some of the benefits of speaking with a financial advisor about inflation include:
Expertise and guidance: Newcastle Financial advisers are trained to help clients understand and manage the potential impact of inflation on their financial goals. They can provide guidance and expertise on how to position a portfolio to protect against inflation, and can recommend investments and strategies that are specifically designed to provide protection against inflation.
Customized advice: Newcastle financial planners can provide personalized advice that is tailored to a client's individual circumstances and goals. This can include taking into account a client's retirement goals, risk tolerance, and other factors to develop a strategy that is designed to protect against inflation.
Ongoing support: Newcastle financial advisors can also provide ongoing support and guidance to help clients manage their investments and adapt to changing economic conditions, including changes in the rate of inflation. This can help to ensure that a client's portfolio is positioned to protect against inflation over the long term.
Overall, speaking with a financial advisor about inflation can provide valuable expertise and guidance to help clients protect their financial goals against the potential effects of inflation.