When you are investing with a long term horizon – say for retirement, for your kids’ college fund or for medical expenses, you should always take the effect of inflation into account. Because of inflation, you end up paying more than you used to for the same things. And as it is an inescapable aspect of the economy, your investment strategy should be adjusted to deal with it.
Although there have been brief deflationary periods in the US, a steady increase in prices has always been witnessed throughout history. A look at the latest consumer price index reveals a 0.1% increase in March even though the economy is still only in the initial stages of recovery.
Inflation affects all sectors of the economy differently. In general, food commodities and metals are easily influenced by inflationary trends and prices in these areas can see huge swings. As inflation adversely affects your spending power, it can have a negative effect on your portfolio and erode the actual worth of your money.
You can protect your investment portfolio from the impact of inflation to a large extent. Here are a few ideas that you can use.
Invest in companies that provide essential products or services, like telecommunications, food, fuel, and medicines. No matter what the price, these items will still have to be bought on a regular basis. So while demand may drop marginally it can never be extinguished altogether. You can invest in sector specific funds or buy stocks of individual companies. Go for reliable companies, which have a low debt and above average profit margins.
Housing is still a good investment because even in a moderately growing economy, house values are likely to increase, especially after the steep declines that we’ve seen in the last 2-3 years. Invest for the long term so that you don’t have to worry about minor fluctuations.
Invest in stocks and bonds of a country that is witnessing rapid growth. A high growth rate, and hence higher returns on your investment, will help you outpace inflation.
Pay attention to the market’s ebbs and flows and keep track of your investments. You should make appropriate portfolio adjustments to deal with a high inflation period. You may have to take more risk with your investments.
You can also avoid the effects of inflation by opting for Treasury inflation-protected securities (or TIPS), which offer increases in principal and interest payment in line with inflation.