Many parts of the economy have seen a spike in prices in the past few months due to tight supply and high demand driven by the post-Covid reopening. Commodities like lumber were particularly impacted, with prices hitting all-time highs in early May.
And now, after decades of being virtually ignored as a serious threat, investors are starting to become spooked by the looming specter of inflation and how it could affect their portfolios.
According to Google Trends, a website that analyzes the popularity of top search terms, interest in the term “inflation” hit an all-time high in 2021 as investors try to determine the best investments for inflationary times.
Recently, prices have begun to come down as supply and demand pressures have started to normalize, but that process could take a few months, or even a year or more to play out, which leaves the outlook for future inflation unclear.
That’s why spending your time worrying about which assets do best during inflation, and making a bet in your portfolio on a specific outcome, could be a losing proposition.
Inflation is not a new phenomenon
Historically, some asset classes tend to perform better than others in periods of rising inflation, just as some outperform when interest rates fall and some fare better in the early stage of an economic recovery.
Take stocks for example.
More often than not, inflation-adjusted returns for stocks are positive (U.S. large-cap stocks outpaced inflation 86% of the time, over rolling 10-year periods since 1926). Of course, past performance doesn’t guarantee any future results.
But some stocks may benefit more than others should inflation pick up; for instance, large value and developed international stocks have shown more positive correlations to inflation over the past few decades.
So with all these mixed signals, what can investors do to help prepare themselves for an uncertain inflation outlook?
Don’t waste your time trying to figure out the “best” investments for inflation protection. Instead, own the whole market at all times.
Your best hedge against inflation is diversification
Here’s why we encourage you to own the whole market in your investment portfolio. Anything can happen at any time, with little notice.
At Edelman Financial Engines, our asset allocations are designed to deliver across all possible scenarios, not to attempt a guess at which one specific scenario may play out in the near future. For example, our client portfolios own some stocks in areas that can benefit in an inflationary environment, and others in sectors that tend to benefit more in falling-inflation environments.
But diversification doesn’t just mean you should own lots of stocks. It also means you should own lots of asset classes – like bonds and government securities – in addition to stocks.
With adequate diversification, you can help protect yourself from catastrophic losses if something goes wrong with a single stock or a single asset class.
Every day at Edelman Financial Engines, we create diversified portfolios for our clients, built for all different types of inflationary environments. If you’d like us to do the same for you, just give us a call at (833) PLAN-EFE.
Investing strategies, such as asset allocation, diversification, or rebalancing do not assure or guarantee better performance and cannot eliminate the risk of investment losses. There are no guarantees that a portfolio employing these or any other strategy will outperform a portfolio that does not engage in such strategies. Funds and ETFs are subject to risk, including loss of principal. All investments have inherent risks. There can be no assurance that the investment strategy proposed will obtain its goal. Past performance does not guarantee future results.