The Implications of Rising Inflation

November 17, 2020

If you’re going to plan for your financial future beyond a year or so from today, inflation has likely been a consideration. Typically, investors have planned on an inflation rate around 3 percent, but even minor fluctuations in that rate can have significant implications for where you invest your money.

Inflation has the biggest impact on the value of your assets over the long-term, making it most relevant for retirement planning and estate planning. If you’re thinking about your finances in terms of decades, not years, there are a few things to keep in mind.

The State of Inflation

2015 marked a recent low in inflation, as year-over-year rates dipped to less than one percent. In recent years, that rate has risen again to around two percent, closer to the long-term average we’ve come to expect. But 2020 has not been a typical year.

The COVID-19 pandemic has sent shockwaves through nearly every aspect of American society, and its long-term implications are unclear. What seems likely is that another stimulus package is coming for individuals, small business, and corporations alike. And as Forbes points out, “You simply cannot cancel interest rates, pump untold amounts of new money into a seized-up economy and expect it not to create inflation.” If increased inflation is on the way, investors will need to take note.

Weighing Risk Against Reward

Any asset appreciating slower than inflation will ultimately lose value in the long run. Financial planners already know this, which is why no one will tell you to save for retirement in a typical savings account.

But there are some investments that might make sense in a low-inflation environment that will be drowned out by inflation if rates rise as predicted. One of the most noteworthy is a CD ladder. Typically seen as a safe option for investors who don’t want to test the volatility of the stock market, CD rates rarely exceed two percent — and most CD rates are at rock bottom right now, thanks to historically low federal interest rates. If inflation surpasses three percent, CD ladders may actually lose money over time.

Inflation-Proof Assets

There’s no magic bullet that will protect your wealth, but you can take some solace in the fact that inflation is usually a relatively minor factor in the value of your assets. Even safe options like ETFs and government bonds will fluctuate more due to changing interest rates and other environmental factors than they will from inflation.

In the long term, cash assets are guaranteed to lose value to inflation, while the stock market is all but guaranteed to outperform it. As long as your assets are distributed in such a way that your expected return is higher than 3-4 percent year-over-year, you can decide the best way to balance liquidity and growth.

One of the safest possible investments is in Treasury Inflation-Protected Securities, which are bonds backed by the U.S. Government and protected against rising prices. When they mature, the investor will be paid back either the original principal or the principal with inflation factored in, whichever is greatest. Your money won’t grow, but it won’t lose value, either.

Some investors have also sworn by gold as an inflation-proof asset, but the data on this is shaky. The reasoning goes that gold will hold its value when currencies depreciate, but gold is still a commodity and thus subject to changes in buying power. The price of gold over the last ten years has been as high as $2,000 per ounce and as low as $1,000 per ounce, so it’s reasonable to doubt its stability as a hedge against inflation.

Finally, real estate investment trusts (REITs) have historically proven to be an organic hedge against inflation. As prices rise and fall, so do house prices, which means that REIT returns rise as inflation increases. REITs also offer investors more diversified portfolios than bonds. The downside is that housing-specific fluctuations in the economy, such as the sub-prime mortgage crisis of 2008, can sink the value of REITs.

Talk to First Western Trust

Inflation usually isn’t the most significant factor when it comes to the long-term value of your investments, but it’s worth keeping in mind. You need to balance risk, return, and liquidity, and the distribution of your assets will vary depending on the returns you expect to see.

If you’re wondering if your portfolio is safe, talk to First Western Trust today. We’ll take a holistic look at every aspect of your finances, income, and liabilities to craft a tailored financial plan that’s designed with your goals and priorities in mind.