The Consumer Price Index jumped 8.5% in March from one year prior, reaching highs not seen since the beginning of the Reagan administration. The impact of inflation is being felt throughout the global economy with the prices of food, energy and other necessities creeping up, and there are concerns for workers because inflation is outpacing the growth in wages. 

Among those who are most sensitive to rising prices are people with lower incomes who tend to spend a greater proportion of their paychecks on food and energy costs and retirees living on limited or fixed incomes. Those nearing retirement are also being forced to examine their plans and portfolios to see if they’re still on track to meet their goals given the consequences of inflation. Younger people planning for retirement can also take steps to make sure their portfolios are prepared for the challenges brought on by inflation.

Bond Risks

To hedge against inflation risk, portfolios should be carefully balanced. Equities and real estate may benefit from inflation, but holding too much of any asset class could put retirees or those approaching retirement at risk should a market correction come. With those approaching retirement looking for sources of fixed income to make up a sizable portion of their portfolio to shield them from the possibility of stock market turbulence, the bond market has typically been an attractive and relatively stable option.  

As a general rule, retirees need investments in their portfolio to generate returns that exceed inflation so they can keep up, and that may not be easy with fixed-income investments, such as bonds. Bond prices rose because of falling interest rates in the last few decades, but that’s no longer the case. With interest rates on the rise, the prices of existing bonds are dropping, and those sold before they mature will lead to losses.

Those investing in bonds for income may want to consider using a bond ladder and allocating their funds among bonds with different maturities. By purchasing a combination of bonds with terms between one and five years, for example, and holding them to maturity before reinvesting in more laddered bonds, they reduce the risk that stems from falling bond prices. Treasury inflation-protected securities (TIPS) are also a good way to insulate funds from inflation risk, but waiting until inflation is on the rise to purchase them means they’ll likely be too expensive since the market has already priced in their adjusted payments.  

Impact on Equities

Modest and steady inflation can benefit the stock market, and equity investments can provide a hedge against inflation under the right conditions. However, the combination of higher input costs and lower sales because of decreased consumer demand can negatively impact corporate profits and stock prices. Higher borrowing costs also impact companies with a lot of debt, which leads to a reduction in cash flow.

High inflation can lead to volatility in the stock market and lower returns (when adjusted for inflation), at least in the short run. From a historical perspective, value stocks have performed better than growth stocks during periods of increased inflation, as higher rates can benefit stocks with less debt and near-term earnings potential. This could be something that persists following more than a decade of growth stocks outperforming value stocks.

Tech and other large-cap growth stocks that fueled market growth in recent years may not perform as well in a high-inflation environment, and rebalancing with more investment in value-oriented and small-cap stocks may be one way to protect portfolios from inflation. Each sector feels the impact of inflation differently; for example, energy and banking firms may benefit from higher commodity prices and interest rates.

Finding Balance

Because the impact of inflation is dynamic and not evenly distributed, some asset classes will fare better than others. Commodity prices, while volatile, are experiencing a surge. Cash is losing its value faster than it has in decades, and even though CD interest rates will likely notch a bit higher, it’s unlikely they’ll compare to the rates seen in the 1980s, and they won’t be able to keep up with the inflation seen in the past few months. At the same time, keeping a reasonable amount of cash on hand allows portfolio holders to weather a market correction and quickly deploy liquidity elsewhere when needed.

Real estate is a mixed bag. Homeowners have seen the values of their homes rise dramatically in recent months, and those with fixed-rate mortgages may be locked into lower rates than we’ll see for a while. Those looking to buy a home face higher prices and rising borrowing costs. With residential rents likely to continue to rise, residential real estate investors and those holding REITs could see increasing returns even as construction materials and related costs increase.

With higher costs of living expected and interest rates, which have been historically low for a while now, finally ticking up, many people are reexamining their retirement portfolios and looking to find ways to compensate that fall within their risk appetite. The long-term implications for those who don’t plan to retire for a while and are committed to diligently and consistently saving will likely be less severe than for those who are approaching retirement or are already retired. Making sure retirement portfolios are balanced and set up to mitigate against inflation and other risks is something that should be done on an ongoing basis. Otherwise, retirement plans may have to be postponed or, in some cases, retirees may find themselves returning to work.