The Impact of Inflation on Investment Portfolios

Inflation can have both visible and less-obvious ramifications for your portfolio, so it’s wise to review your investments during periods of inflation so as to assess any changes necessary.

Certain asset classes perform particularly well in inflationary environments, including real assets like infrastructure and index-linked bonds as well as gold.

1. Liquid Assets Appreciate Less

As inflation rises, an investment’s purchasing power decreases and this reduces real (inflation-adjusted) returns for investors.

Numerous factors influence inflation, including both demand-pull and cost-push factors. The COVID-19 pandemic, geo-political tensions, and rising oil prices all contributed to today’s inflationary environment.

Investments that provide protection from inflationary pressures are wise investments. Renewable energy investment trusts may offer some form of inflation protection through their ability to pass along increased input costs to consumers; or there’s the more generalist First Sentier Global Listed Infrastructure Fund with its target 4% yield yield as another alternative.

Bonds tend to be one of the asset classes most vulnerable to inflation due to their fixed payments; however, inflation-indexed bonds (such as TIPS ) may help investors keep pace with inflation more easily; though even these investments don’t offer complete protection.

2. Investments with Fixed Returns Don’t Keep Pace with Inflation

Inflation threatens the value of assets. To preserve your savings and investments, it’s wise to pursue investment returns that exceed inflation rates.

High inflation can severely diminish returns from fixed-income investments like corporate and government bonds or certificates of deposit. While nominal interest rates matter less than their real rate of return – which subtracts inflation from your earnings – real returns matter even more.

The most successful inflation-beating investment portfolios typically consist of stocks that can pass rising input costs onto consumers, like utilities or consumer staples companies. You could also consider purchasing inflation-indexed bonds directly from the U.S. Treasury or through exchange-traded funds; real estate can also prove invaluable; its value increases as prices do, while rental income keeps pace with inflation – but you should allocate only a portion of your portfolio towards this asset class.

3. Asset Classes That Perform Better in Inflationary Environments

While inflation is a top investment concern, selecting an asset mix that fits within an investor’s existing portfolio, time horizon and risk tolerance is also important. You should take into account which economic scenarios could play out and how exposed your portfolio is.

Investing in investments that generate an increasing stream of revenues tends to perform best under inflationary environments. This includes equity such as oil and gas companies that can pass along rising input costs to their customers as well as those offering floating rate interest like leveraged loans.

Real assets, including commercial real estate, infrastructure and commodity-linked exposures, tend to perform exceptionally well in inflationary environments. This could be because their revenues are directly tied to inflation trends or because they provide essential services like power, water or natural resources that economies around the globe require for economic development. Furthermore, these real assets usually boast low correlations to other asset classes and the potential to generate attractive returns over full market cycles.

4. Asset Classes That Perform Worse in Inflationary Environments

Cash and fixed rate bonds tend to fare poorly in inflationary environments as their returns don’t rise with inflation; their values decrease as prices increase.

Stocks don’t perform significantly better than bonds either, typically earning a risk premium which declines during periods of high inflation (compared with their risk-free rate) while they typically provide returns that surpass inflation over long periods.

Inflation can be an unwelcome addition to your investment portfolio, but by understanding its effects against other variables like financial goals, risk tolerance and time horizon, it becomes easier to make wise investments decisions. Selecting assets with revenue streams tied directly to inflation – such as real estate and energy companies – often outshone those without rising with inflation; similarly this trend holds true across sectors in the equity market such as technology, commodity or financial stocks.

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