How Does Inflation Affect Investments?

As high-net-worth investors, you’ve worked hard to build your wealth. Yet in today’s economic climate, the specter of inflation looms large, threatening to erode the value of your carefully cultivated assets. So, how does inflation affect investing?

Inflation can impact various investment types differently:

• Cash and savings accounts: Lose purchasing power over time
• Bonds: Face value declines as interest rates rise to combat inflation
• Stocks: May provide a hedge, but can be volatile in the short-term
• Real estate: Often keeps pace with inflation, but can be illiquid
• Commodities: Tend to rise with inflation, but can be unpredictable

In this article, the high-net-worth wealth managers from Avidian Wealth Solution dive into the many ways inflation can affect different investment vehicles, and explore strategies to preserve and potentially grow your wealth in an inflationary environment. 

Given the difficulty inherent in navigating these economic headwinds, we strongly recommend consulting with a qualified financial advisor to tailor these insights to your unique financial situation and goals.

What is inflation risk?

Inflation risk, also known as purchasing power risk, is the potential for the value of an investment or cash flow from an investment to decrease due to inflation, reducing its purchasing power. As the general price level of goods and services in an economy increases, each unit of currency buys fewer goods and services.

​​This risk can significantly impact high-net-worth investors, potentially eroding the real value of their wealth over time. Therefore, understanding inflation risk can help investors make more informed decisions about their portfolio allocations and long-term financial planning.

How does inflation affect investing?

By understanding how inflation impacts different types of investment accounts, you can better collaborate with advisors to create a diversified portfolio that aims to preserve and grow wealth across various economic conditions. 

The key is to strike a balance between protecting against short-term inflation and pursuing long-term growth, all while keeping individual risk tolerance and financial goals in mind. However, investment management services and solutions will differ depending on the investment vehicle’s unique inflation risk.

Here is how inflation can affect investments:

1. Cash and savings accounts

In an inflationary environment, cash and traditional savings accounts often struggle to maintain purchasing power. As the cost of goods and services rises, the fixed amount in these accounts buys less over time. 

While high-yield savings accounts and money market funds can offer slightly better returns, they may still lag behind the inflation rate. This erosion of value can be particularly concerning, as larger cash reserves may be significantly impacted.

2. Bonds

Inflation can be particularly challenging for fixed-income investments like bonds. As inflation rises, central banks typically increase interest rates to combat it. This leads to a decline in the market value of existing bonds, especially those with longer maturities. However, not all bonds are equally affected. 

Treasury Inflation-Protected Securities (TIPS) and floating-rate bonds can help mitigate some inflation risks. To combat this, you may want to consider diversifying your bond portfolios and adjusting durations based on inflation expectations.  A good rule of thumb is to avoid duration as rates are rising, so if you use TIPS as a hedge against inflation consider shorter duration TIPS or ETFs that target that objective.

3. Stocks

Equities can offer a potential hedge against inflation, as many companies can pass increased costs on to consumers, maintaining their profit margins. However, stock performance during inflationary periods can be sector-specific and volatile.

4. Real estate

Real estate is one alternative investment solution that has the ability to provide improved cash flows during inflationary periods. Inflation typically results in higher rents which are a tailwind to the property owner.  In some markets rents have contractual increases that tie back to inflation rates which offer embedded protection.

Real Estate Investment Trusts (REITs) can offer exposure to this asset class with greater liquidity and diversity than direct property ownership. However, it’s important to note that real estate markets can be local and cyclical, requiring careful selection and management.

5. Commodities

Commodities, precious metals, energy, and agricultural products, tend to appreciate during inflationary periods. As the cost of production rises, so do commodity prices. Gold, in particular, is often viewed as an inflation hedge and a store of value. Commodities particularly excel in warding off the impact of an inflation surprise resulting from a shock to the availability of a natural resource.  Hurricanes or political events that disrupt the supply of oil are examples of these surprises.

However, commodities can be volatile and may not offer income, making them a more tactical holding for many investors. Exposure through commodity-linked stocks or ETFs can also offer a more liquid and manageable way to include this asset class in a portfolio.

Is it good to invest during inflation?

Investing during inflation can be challenging, but it can also offer opportunities. With a strategic approach, you can implement financial risk management strategies to help preserve and potentially grow your wealth despite inflation’s impact on certain assets. 

Here are some potential benefits of investing during inflation:

• Investing helps maintain the real value of wealth over time and can counteract the erosion of value in cash holdings.
• Some investments (like stocks of companies with strong pricing power) may outpace inflation rates.
• Inflation and rising interest rates can lead to lower stock valuations, possibly creating buying opportunities for long-term investors.
• Fixed-rate debts (i.e. mortgages on investment properties) can decrease in real value
• International investments can help protect against domestic inflation and offer exposure to different economic environments.

Here are some potential challenges of investing during inflation:

• Short-term performance can be unpredictable and requires a strong stomach for market fluctuations.
• Rising interest rates can decrease bond values and may require adjustments to prior fixed-income strategies.
• Inflation may present some difficulty in forecasting business performance and valuations.
• Investing during inflation requires careful analysis and potentially more frequent portfolio reviews.

Remember, while investing during inflation can offer advantages, the decision to invest should be made strategically and with professional guidance. Together, you can take into account your personal financial situation, risk tolerance, and long-term goals to effectively manage risks and capitalize on opportunities.

When evaluating investment performance during inflationary periods, it’s also crucial to consider the inflation-adjusted rate of return. This metric provides a more accurate picture of your investment’s real growth by accounting for the effects of inflation.

Are your investment strategies inflation-proof? Let’s talk.

Understanding how inflation affects investing is crucial for those seeking to better preserve and grow their wealth while navigating geopolitical risk and inflationary pressure. From the erosion of cash holdings to the potential opportunities in real estate and commodities, inflation’s impact can reverberate across all asset classes.

At Avidian Wealth Solutions, we offer bespoke investment strategies that aim to help protect and grow your wealth, even in challenging economic climates. Our experienced team can help you put plans in place that aim to help your portfolio handle inflation, geopolitical risks, market volatility, and more.

Don’t let inflation erode your hard-earned wealth. Schedule a conversation with one of our advisors in Houston, Austin, Sugar Land, or The Woodlands today to help align your investment strategies with your long-term goals.

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