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Inflation and investing: Why a financial plan matters

Nate Hitch Profile Picture
02.23.22

Lately, we’ve been hearing a lot about inflation, but inflation is nothing new for investors. Historically, from 1957 to 2021, inflation averages about 3.57 percent. We’ve seen it at its highest of 13.6 percent in June 1980. I’ve had a lot of client questions about inflation. Many clients ask if it’s good or bad. Some inflation is a good thing, it shows that the economy is healthy and growing. But too much can put a strain on finances, especially retirees who are on fixed incomes. It can also affect those nearing retirement as high inflation can eat at retirement savings. My best advice to clients? Develop a financial plan or if you already have one, review it and see how you can make it work for you in an inflationary environment.

What is inflation?

Inflation is the increase in prices of goods and services in an economy. A healthy economy typically sees inflation of about 2 percent. In this regard, inflation is a good thing. In simplest terms, inflation means you’re going to spend more money for gas, food and other living expenses. You’ve likely noticed that your money is not going as far as it normally does.

The biggest factors impacting inflation are supply and demand, but other factors such as unemployment and expected prices of goods can also have an effect. Inflation can be demand driven, meaning people are willing to pay more for something. It can also be supply driven usually where there are supply constraints causing prices to increase.

Why inflation matters for investors

When most people think of inflation they think about the immediate effects, increased prices. But why does it affect investors? As you invest for retirement, or other future plans, you need to account for the increased cost of living. In 20 or 30 years when you retire, the cost of living could be much higher. Think about how much gas or a loaf bread cost 20 years ago. Prices of goods and services change over time and your investment and financial planning needs to account for that.

Right now, inflation is more apparent as interest rates are near historical lows. Is the current inflation level a bad thing? The answer here depends on where you are in your investment timeline: Growing your wealth, pre-retirement or trying to generate income in retirement. Let’s focus on pre-retirees and retirees needing to generate income. At these investment stages, clients may be focused more on principal preservation than growth as they were in their accumulation years. Many of these solutions to help clients preserve principal are sensitive to interest rates. Currently, we’re seeing inflation mixed with low interest rates. When interest rates and inflation are much tighter a client might not be able to gain much growth, but it would be enough to preserve their principal and not lose too much of their purchasing power for future years.

Inflation and interest rates

One of the reasons higher inflation is hitting investors is due to very low interest rates not only here in the US but globally. With inflation higher and interest rates low, the prices of the goods and services we need to buy are increasing faster than interest bearing investments are. For clients dependent on a fixed income, they are losing purchasing power faster than they have since the early 2000’s. Historically, clients could look to CD’s, fixed annuities or even bonds to help mitigate their investment risk, preserve principal and keep pace with inflation. But many of these products generally don’t perform well in high inflation.

Your financial plan can help

Investors who are in the pre-retirement stage or retirees who need to generate income now have to look to alternative investment solutions that they haven’t considered in the past if they want to help maintain their pre-retirement lifestyle. During the current economic client, investors should be considerate of not only asset allocation but more importantly than ever, product diversification. Fitting these two pieces together requires thinking about your goals, expectations and timeline. To avoid losing too much purchasing power for future needs, you could look to asset classes that have done well historically in high inflationary times. Here are a few a considerations:

Commodities: Because commodities are real assets, they tend to do well in an inflationary environment. Just as the prices of goods and services go up, so does the prices of commodities, which make them a good investment option.

Real Estate: Like commodities, real estate investments are tied to real assets which tend to gain in value due to inflation. Even if you don’t own property or plan to, you can still invest in real estate through a number of investment options

Stocks: Stocks can be a good option as well because companies tend to be profitable during inflationary times due to rising prices. This is especially true for companies that provide basic goods and services that consumers will always need.

Inflation protected options: These include inflation protected bonds and even Treasury Inflation Protected Securities (TIPS). Both are adjusted based on the consumer pricing index, which measures inflation.

Here are a few product diversification considerations:

Annuities: Variable/Structured/Equity Index annuities can provide guarantees that you can not find in typical asset class investing. Some of these guarantees can be limited or no market loss, guaranteed income in retirement and long term care planning.

Structured Investments: These can provide downside protection while keeping clients invested in the market helping them achieve long term financial goals.

Life Insurance: Life insurance is not usually considered, however this can be a good consideration that helps clients stay invested by linking growth to a protection policy for their loved ones.

Your financial plan can help you decide how much risk you’re comfortable with based on your timing and goals. You can choose options that are riskier but may gain more during increased inflation. You may choose a less risky plan that helps you maintain your returns and keeps up with inflation. Your financial planner can help you look for assets that appreciate and that pay interest that fluctuates over time. Anything that has a locked in rate is not going to perform well during the low interest rate, high inflation environment like the one we’re currently in.

While these are a few options, it’s important not to deviate too far from your financial plan. Your financial plan is your blueprint for how to allocate dollars, potentially into other investment products, to best fit goals, expectations and timeline. When helping clients and addressing their concerns around market conditions that effect their goals, the financial plan we create together gives them clear action steps to help them in the future.

The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material nor is it a recommendation. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Nate Hitch and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. Investing involves risk and you may incur a profit or loss regardless of strategy selected, including asset allocation and diversification. Past performance does not guarantee future results. Future investment performance cannot be guaranteed, investment yields will fluctuate with market conditions.

Treasury Inflation-Protected Securities (TIPS) provide protection against inflation by adjusting their principal amount annually based on the Consumer Price Index (CPI) and then paying interest on that new amount. The principal amount is readjusted every year based on the prior year's CPI, meaning it can go down as well as up. When TIPS mature, the investor receives either the current principal value or the original amount invested in the TIPS bond, whichever is higher. TIPS offer the benefit of diversification as well as being a hedge against inflation. Their principal value is guaranteed by the U.S. government and they are highly liquid - they can be bought or sold before they mature. If sold prior to maturity an investor will receive the current market value, which may be more or less than the amount invested. TIPS will lose value in deflationary periods. They should be held only in nontaxable accounts such as an IRA because increases in the principal amount are considered taxable income in the year they occur even though the principal amount is not actually returned to the holder until maturity.

In general, the bond market is volatile, and fixed income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities.) Fixed income securities also carry inflation risk, liquidity risk, call risk, and credit and default risks for both issuers and counterparties. Unlike individual bonds, most bond funds do not have a maturity date, so holding them until maturity to avoid losses caused by price volatility is not possible. Any fixed income security sold or redeemed prior to maturity may be subject to loss.

Nate Hitch Profile Picture

About Nate Hitch

Nate Hitch has served as a financial advisor since 2006. Through Raymond James, one of the largest and most respected independent financial services firms in the country, he has access to a vast universe of investment and planning resources. He can leverage these resources to create your personalized financial plan based on your unique situation, attitudes, preferences and goals. Before assuming his current role, Nate served as a regional vice president at River Source working with advisors on retirement and tax solutions with their clients. Nate holds a bachelor’s degree from Gustavus Adolphus College. He has also obtained his Series 7, 63, ...

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