How to invest smartly when inflation picks up

  • Inflation can present a number of challenges for investors.
  • Here are some moves you can take to protect your money from rising prices and even take advantage of the environment, according to financial advisors.

Prices are picking up faster than usual, and the threat more investors are talking about is inflation.

Inflation presents challenges for investors in a number of ways, experts say.

Most simply, as the cost of living goes up, your returns don't go as far. That's a particularly vexing problem for retirees, who may rely mostly on their profits to pay their bills, whereas younger people also have their paychecks (and high-inflation has tended to lead to higher wages).

Another risk is that the Federal Reserve will lift interest rates to curb rising costs, which tends to drag down equities.

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"In general, inflation is usually negative for stocks," said Amy Arnott, a portfolio strategist at Morningstar.

She pointed to history as proof: Between 1973 and 1981, inflation rose by more than 9% a year. During the same period, stocks shed about 4% annually.

But don't panic — doing so has never helped an investor.

First of all, we still don't know if rising prices will become the new normal or if they're just a temporary result of a nation emerging from a pandemic and a year of lockdowns and restrictions. And even if costs continue to increase at a steady clip over the next few hears, history shows that stocks beatinflation over the long run.

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The average annual return on stocks was around 11% between 1900 and 2017, according to calculations by Steve Hanke, a professor of applied economics at Johns Hopkins University in Baltimore.

After subtracting the cost of inflation, that average annual return remains at a handsome 8%.

Still, there are some moves investors can take to protect their money from inflation — and even take advantage of the environment, financial advisors say.

Investments to avoid amid inflation

Because an interest rate hike by the Fed might be in store, experts recommend that you don't tie up too much of your money now in any long-term bonds or certificates of deposits. Doing so could lead you to miss out on higher rates later.

"I advise clients at present to focus on short to intermediate-term bonds and avoid any investments that have 'long term' in the name," said Doug Bellfy, a certified financial planner at Synergy Financial Planning in South Glastonbury, Connecticut.

Another area you may want to stay away from is growth stocks, or companies with higher-than-average expected earnings, said Alex Doll, a CFP and president of Anfield Wealth Management in Cleveland, Ohio.

"Growth stocks tend to perform worse because they expect to earn the bulk of their cash flow in the future," Doll said. "And as inflation increases, those future cash flows are worth less."

He pointed to Tesla as an example. "Tesla is down over 20% this year because of a few issues, but inflation and rising interest rates are a big factor," Doll said.

How to take advantage of rising prices

As Doll has been pulling back on his clients' exposure to growth stocks, he's been increasing their allocation to value stocks, or companies trading at below average rates in the S&P 500.

"Value stocks can do a bit better during inflationary periods," Doll said.

That's because these companies are often in industries, such as the financial and consumer staples sectors, that get hit less hard by inflation, Doll said: "These industries tend to perform better because they have more pricing power and are able to increase their prices with inflation better than other industries."

These businesses are also usually already well-established, he said, and so you don't have to worry as much about their expected growth waning in value.

Another good match for investors worried about inflation are Treasury Inflation Protected Securities, or TIPS, said CFP Nicholas Scheibner, a wealth management advisor at Baron Financial Group in Fair Lawn, New Jersey.

These securities carry a similar risk as other fixed income investments, he said, but they add an adjusted principal amount if inflation increases.

Other hedges to inflation include investing in real estate, gold and even cryptocurrencies, advisors say.

"Real estate performs well because landlords and property owners see the values of their properties increase," Doll said. "But also landlords can somewhat easily pass-through rent increases."

The argument for investing in cryptocurrencies or gold amid inflation is that those assets are not damaged by the eroding value of cash.

However, both are highly volatile and shouldn't make up more than 5% of your portfolio, experts warn.

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