Lots of investors worry about inflation. After all, prices are rising for some everyday goods, services, and important commodities. The fastest increases in decades could threaten growth in certain sectors, impact household spending, and affect the value of savings and investments. These concerns will only grow as the economy returns to pre-pandemic levels. So the important question is — how much should you really worry if you’re a long-term investor?
Here are three things to keep in mind
In everyday language, we often talk about any price increase as “inflation.” However, it’s important to distinguish between three factors at play during this post-pandemic recovery. Understanding the differences can help investors to stay balanced and be properly positioned in the years to come.
- Some prices are simply bouncing-back from historically low levels. Oil, for instance, plummeted at the onset of the nationwide lockdown last year, with the front-month futures contract (a type of investment that is based on the price of oil) falling into negative territory for the first time in history. Even with no changes to the oil industry, it would be expected for prices to rebound as the economy reopens and the demand for oil grows. The fact that these price increases are large on a percentage basis is due to the low starting points last year.
- There are supply and demand imbalances in certain industries that are causing prices to soar. This is true in semiconductors, housing construction, agriculture, gasoline, and many more areas. In most cases, this is what captures the attention of news headlines and the general public. In many of these cases, supply and demand imbalances should resolve themselves over time. And while this may be “inflationary” if it affects a wide variety of goods at the same time, this is not usually what economists worry about when they think of that term. After all, the skyrocketing price of toilet paper during the pandemic wasn’t referred to as inflation, since it was understood to be temporary.
Chart: Many economically-sensitive commodities have seen their prices rise during the recovery
Sources: Clearnomics, Bloomberg
- There’s been a broad rise in prices across the economy due to monetary and fiscal stimulus. This is textbook inflation caused by increases in the money supply and/or the velocity of money (the pace at which money is spent). Unlike an energy pipeline disruption, the effects of this type of inflation can be harder to see.
How do rising prices affect your portfolio?
In a nutshell, rising prices affect you in many different ways. Base effects are by their very nature temporary and should generally not cause investors to drift from their long-term plans. In contrast, supply and demand shocks can lend themselves to sector positioning and tilts within portfolios.
What’s the best way to invest long-term when prices are on the rise?
Effects that are more temporary should not cause investors to lose sight of their long-term financial plans. Some securities such as Treasury Inflation-Protected Securities (TIPS), for instance, can help protect investors from broad and steady increases in prices as measured by the Consumer Price Index. Persistent, steady inflation is often what drives interest rates higher and impacts stock market valuations. This is one reason that staying invested in inflation-resistant asset classes, including stocks, is often better than holding cash whose purchasing power is slowly and quietly eroded.
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