As you know, inflation heated up in 2021. If you’re getting close to retirement, how concerned should you be about inflation’s impact on your lifestyle and your investment strategy?
To begin with, it’s important to note that the key factors driving inflation in 2021 were somewhat unusual. The global economic recovery, while still incomplete, led to greater consumer demand for goods and contributed to the supply chain bottlenecks. At the same time, government spending increased in response to the continued effects of the pandemic.
So, it’s quite possible that after these factors fade in intensity, we may step back from the hot inflation of 2021, which really was quite significant – in fact, at one point in the year, the Core Consumer Price Index (CPI), which measures the changes in the price of goods and services, excluding food and energy, showed the largest 12-month increase since 1992.
But even a moderate inflation rate, such as we’ve experienced the last few decades, can, over time, greatly reduce your purchasing power. And in a few years, when you retire, you may be especially vulnerable to inflation, as you will no longer receive yearly salary increases that can help you stay ahead of the cost of living. Plus, you’ll need to protect yourself from the threat of outliving your resources. Consequently, you need to be aware of how inflation will affect your investment portfolio.
Here’s how the two main categories of investments respond to inflation:
- Stocks – Inflation can affect stocks in different ways. “Value” stocks – those companies whose share prices are relatively low, based on earnings and other factors – can show positive results during inflationary periods. Conversely, growth stocks, which, by definition, are those companies that expect to see most of their cash flow in the future, don’t do as well. Nonetheless, you will need to maintain some growth potential in your portfolio throughout your retirement years.
- Bonds – Rising inflation will erode the value of a bond’s future income, so, during inflationary periods, bond prices generally fall. Longer-term bonds will be affected the most as they are most sensitive to interest rate changes. This does not mean, though, that you should get rid of your bonds – they still provide a source of regular income and can help reduce the impact of market volatility that can affect a stock-heavy portfolio.
But rather than try to guess which investments are best for an inflationary environment, you’re better off following a long-term strategy based on your goals, risk tolerance and time horizon.
Inflation is a fact of life – but by making the right moves, you don’t have to let it devalue your future.
Investing in equities involves risks. The value of your shares will fluctuate and you may lose principal.
Before investing in bonds, you should understand the risks involved, including credit risk and market risk. Bond investments are also subject to interest rate risk such that when interest rates rise, the prices of bonds can decrease and the investor can lose principal value if the investment is sold prior to maturity.