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Should You Be Worried About Inflation? Part 2: What We Can Do About It

In our last piece published earlier this month, we covered the recent uptick in inflation, and what to make of it from a historical context. For investors, it’s important to take a step back and look at the big picture instead of acting on breaking news. But what if inflation does get out of hand, and stays that way for a while?

Earlier this year, the Federal Reserve insisted that rising inflation rates were transitory and should steady later this year. However, at the FOMC meeting in June, the Fed pivoted, considerably raising its expectations for inflation and the time frame for when it will next raise interest rates. While the short-term borrowing rate will remain anchored near zero for now, officials announced that two rate hikes could come as early as 2023. The Fed also raised its inflation expectation to 3.4%, a full percentage point higher than the March expectation. Some economists predict that rate hikes could come sooner rather than later if the economy continues to run a bit hot.

Of course, we can hope that inflation stabilizes, but we know that the future remains uncharted and need to keep a realistic outlook.

Explaining Inflation Doesn’t Predict It

Consider this: Nearly any outcome is possible, and no outcome is inevitable. Studying all of the historical data in the world cannot guarantee that future results will follow old patterns. Not to mention that expert forecasts vary widely. Even excellent explanatory models rarely serve as effective predictive models.

Let’s take the weather as a prime example. Scientists can readily explain why earthquakes or hurricanes occur, but our ability to forecast times, locations and severities remains shaky at best. The same can be said for inflation. We can observe the historical patterns, but accurate predictions remain as elusive as ever. There are simply too many variables: COVID-19, political action, the Federal Reserve, other central banks, consumer banks/lenders, consumers/borrowers, employers/producers, employees, investors (“the market”), sectors (such as real estate, commodities, and gold), the U.S. dollar, global currency, cryptocurrency, climate change, financial economists, the media, the world, time … and YOU.

One, all, or some of these factors could throw off any predictions about the time, degree, or severity of future inflation. Besides, as an investor, you really only have control over the last two: You, and your investing behavior.

Because We Can’t Predict the Future, We Diversify

What all of this does mean—and should come as good news to long-term investors —is that diversified investing remains the preferred strategy for being prepared for whatever the future holds.

Some investments seem to shine when inflation is on the rise, while others deliver their best results at other times. Because we never know exactly when inflation might rise or fall, or the magnitude and duration of it, we believe an investor’s best course is to diversify into and across various investments that tend to respond differently under different economic conditions.

For example, until earlier this year, value stocks had been underperforming growth stocks for quite a while. You may have been tempted to give up on them during their decade-plus lull (during which inflation remained relatively low). And yet, when inflation is high or rising, value stocks have tended to outperform growth, as has been the case year-to-date.

Stocks Could Be the Best Way to Outpace Inflation

Provided time is on your side, the stock market is your greatest ally against inflation.

Over time, global stock market returns have dramatically outpaced inflation. For example, as reported by Dimensional Fund Advisors, $1 invested in the S&P 500 Index from 1926–2020 would have grown to $752 worth of purchasing power by the end of 2020, after adjusting for inflation. Had that same dollar been held in “safe” one-month Treasury bills over the same period, it would have grown to an inflation-adjusted $1.49.

But that T-bill growth is not nothing, and can serve as a safe haven during bear markets. That’s one reason we advocate for maintaining an appropriate mix between wealth-accumulating and wealth-preserving investments.

But what’s “appropriate”? It depends on your personal financial goals. The point is, as long as you have enough time to let your stock allocations ride through the downturns, you can expect them to remain well ahead of inflation simply by being in the market.

It’s important to add, no fancy market-timing moves are required or desired when participating in the stock market. In fact, moving holdings in and out at seemingly opportune times is more likely to detract from the vital, inflation-busting role stocks play in your portfolio. In the words of Nobel Laureate Eugene Fama: “The nature of the stock market is you get a lot of the return in very short periods of time. So, you basically don’t want to be out for short periods of time, where you may actually be missing a good part of the return.”

What if You’re Retired and Living Off Your Investment Income?

What if you’re depending on your portfolio to provide a reliable income stream here and now? If you’re retired, (or you have other upcoming spending needs such as college costs), eventual expected returns offer little comfort when current inflation is eating into today’s spending needs.

Again, you can’t control inflation, but you can manage your own best interests in the face of it. Along with a globally diversified investment portfolio, you’ll want a solid strategy for investing for, and spending in retirement.

  • Asset Location: Among your taxable and tax-favored accounts, where will you locate your stocks, bonds, and other assets for tax-efficiently accumulating and spending your wealth?
  • Spending: How much can you safely withdraw from your investment portfolio to supplement your other income sources (such as Social Security)?
  • Withdrawal Strategies: Which accounts will you tap first, and next?

Especially when inflation is on the rise, it’s worth revisiting your existing investment and withdrawal strategies.

Don’t Impulse Sell. Adjust.

What if inflation is taking too big a bite? A common misstep is to abandon your carefully structured investments in pursuit of short-cuts. For example, it may be tempting to unload high-quality bonds and pile into gold, dividend stocks, or other ways to seek spendable income. Unfortunately, we believe such substitutes detract from effective retirement planning. The goal is to optimize expected returns and manage unnecessary risks in pursuit of a dependable outcome. As such, we suggest avoiding dubious detours along the way.

Especially when inflation is on the rise, it’s worth revisiting your existing investment and withdrawal strategies. While some of the belt-tightening choices may not be ideal, they are preferred over chasing unsubstantiated sources of return that could put you at even greater risk.

How Can We Help?

While anyone can embrace the strategies we just described, implementing them can be easier said than done. We hope you’ll contact us today to discuss these and other retirement planning actions worth exploring. After all, making the most of your possibilities is always a smart move, whether or not inflation is here to stay.

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