For more than a decade, inflation has been largely dormant. In recent months, however, economists had expected a slight uptick, but were still surprised by the sharp rise in the Consumer Price Index (CPI) in April, which rose 4 , 2% compared to last year. As an investor, what can you expect if we enter a more inflationary environment?
First, it helps to understand the main causes of the recent price spike. Part of the explanation is simply the result of increased economic activity in the spring of 2021 compared to the same period a year ago, when prices collapsed during the height of the COVID-19 pandemic. . And this reopening of the economy has also resulted in an increase in demand for travel-related services such as hotels, airline tickets and rental cars. Another contributing factor is a widespread shortage of manufacturing materials which has constrained production and pushed up prices for a range of consumer goods.
Will this inflationary pressure continue? It is not easy to make predictions of this nature, but, for now, the Federal Reserve seems to believe that the recent price increases are temporary and, therefore, will continue its policy of keeping interest rates low. . But a few more months of higher than expected inflation could change the view of the Fed and its actions.
Either way, how should you, as an individual investor, react to the potential threat of higher prices? You should keep in mind that inflation affects different types of investments differently. Consider fixed income securities such as bonds, which pay a fixed rate of interest – the nominal interest rate. Because rising inflation erodes the value of a bond’s future income, bond prices typically fall during periods of inflation. This is especially true for longer-term bonds, because of the cumulative effect of declining purchasing power. On the flip side, stocks – especially those of large corporations – tend to perform well during times of inflation, which is perhaps not so surprising given that both incomes and profits tend to perform well during times of inflation. A business can grow at a rate similar to that of inflation. Of course, the term “stocks” is a broad term, and some industries will fare better than others when inflation increases.
Even if inflation continues to rise, you may not want to make any significant changes to your investments. For example, although their prices may go down, bonds can still be valuable assets as they can help reduce the impact of market volatility on your portfolio. And if you already have a good mix of stocks suited to your goals and risk tolerance, there’s probably no need to shake things up.
Here’s another thought to keep in mind about inflation: it reminds you that you’ll still need to have a reasonable percentage of growth-oriented investments in your portfolio to avoid losing purchasing power. . As we have seen, inflation will not always be in hibernation.
Ultimately, your own actions and decisions will determine your success as an investor, but you’ll always want to be aware of how developments like inflation can affect the economy and financial markets. If we enter territory that we haven’t seen in a while, it’s worth staying alert.
Jennifer Barrett (AAMS) is a local financial advisor to Edward Jones.
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