How might higher inflation affect your investments?
The latest figures for US consumer prices showed that the rate of inflation increased the most since September 2008. This is raising fears that we are headed for a sustained bout of inflation.
Rapid price increases lower a currency’s purchasing power, reducing the amount of goods and services you can buy with money.
This damage can be mitigated by investing, although your capital is at risk and different asset classes will offer varying levels of inflation protection.
Inflation can be good for holders of assets, if their values rise faster than the general level of inflation. However, it can be bad for anyone with a fixed income.
Watch the video: How inflation might affect your investments
Bonds are therefore an obvious casualty. Their fixed stream of interest payments become less valuable as the overall cost of goods and services accelerates, sending yields higher and bond prices lower to compensate.
In contrast, low and rising inflation has historically been the sweet spot for equities. US equity returns beat inflation 90% of the time during such episodes. However, when inflation was high and rising, equities beat inflation only 48% of the time.
Commodities and real estate have offered more consistent protection in these environments, beating inflation 83% and 67% of the time respectively. But this has come at the expense of more volatile returns.
Investors ought to choose their inflation hedge wisely.
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