Creating a long-term investment plan and sticking to it through economic ups and downs will help you ride out periods of high inflation.
Inflation Impacts Investments
“In recent years, with spikes in inflation, we also have seen increases in interest rates on investments like savings accounts and short-term cash investments,” said Ryan Swartz, partner and managing director of Creative Planning. “The long-term risk of keeping up with the rising costs of goods and services could merit an increase of allocations to more stocks versus fixed income investments, depending on the situation.”
Inflation is a drag on investment returns, acting essentially like a tax, but over the long-term stocks tend to be good investments to protect against inflation, although not necessarily an “inflation hedge” over the short-term, according to Sonu Varghese, director of investment platforms at Carson Group.
“Companies can raise prices and maintain profit margins if inflation is higher,” he said. “So stocks are a ‘real asset’ in a sense, and long-term stock gains are one of the best ways to create wealth and beat inflation, [unlike] bonds, where the interest payments are nominal and can be worth a lot less in the face of inflation.”
Inflation tends to cause worry and anxiety for investors, creating a hesitancy to invest, which can put downward pressure on share prices, according to Ross Polking, lead advisor at Foster Group.
“Bond investing can be a bit more predictable,” he said. “Inflation tends to drive interest rates higher, thus dollars flow more heavily into fixed income instruments, while previously issued bonds will move inversely to the direction of interest rates. It’s important to remember that the market is always forward-looking. Anticipated inflation tends to be reflected in market prices before the actual inflation even rears its ugly head.”
Inflation initially impacts the economy, mainly the price consumers pay for goods and services.
“While our income is stable, dramatic increases in prices due to inflation means we tend to buy less, which ultimately affects the revenues of companies we buy from; therefore they become less attractive investments,” said Earl Johnson, wealth manager at EverGreen Capital Management. “[This] leads to lower stock market prices and less value of our investments.”
Investing Pitfalls
Many of the major pitfalls investors should avoid stem from letting emotions drive investment decisions in the short term. It is helpful to have a well thought out financial plan that you can use to tailor a long-term investment strategy to keep you on track.
“It is very tempting to let short-term market concerns dictate behavior,” Swartz said. “Markets are very unpredictable in the short term but become much more stable over the long run.”
Investors need to be diversified so that the impact of near-term volatility is minimized and matches their risk profile.
“At the same time, it’s important to remember that time is your best friend forever when it comes to investing,” Varghese said. “Patience pays: the longer your holding period, the more likely you are to see gains. The S&P 500 was higher 81% of the time every five years, 90% every decade, and it has never been lower if your holding period was 20, 25, or 30 years.”
Johnson noted that both consumers and investors have a tendancy to gravitate to “staples” to avoid the pitfalls of high inflation.
“Items such as food, and the producers of goods and services that we will use in good and bad times,” Johnson said. “If you are an investor, pay close attention to your investments that produce goods or services that are mainly considered discretionary — the wise will usually avoid these items only to buy when market conditions recover.”
Alternative Investments
Typically, an alternative investment is anything that falls beyond stocks and bonds and acts differently than those broad markets.
“Cryptocurrency has been all the rage the last couple years,” Polking said. “Gold has been a timeless alternative asset some people love, others hate.
“Real estate, either in the form of direct or passive ownership — potentially in the form of real estate investment trusts have been popular diversifiers on many balance sheets. Hedge funds and private equity are other alternatives that come with much higher required entry points but with a potential for sizable reward.”
For every public market such as lending or fixed income bonds, equity stocks, or real property assets like real estate, there is also a private market.
“Many of the alternatives that can be used to enter asset classes in the private market space can provide higher long-term returns than the public market,” Swartz said. “This past year we have seen this divergence in the private lending area, pockets of private real estate versus public real estate as winners, and even areas of private stock investments in private equity outperforming public stock.”
A globally diversified portfolio tied to a strategic financial plan often can be complemented with alternative investments to provide the opportunity to further diversify but increase long-term expected returns.
Alternative investments can vary across alternative assets like real estate and commodities and alternative strategies like managed futures and market-neutral strategies.
“These tend to be good inflation hedges and also typically tend to be non-correlated to stocks and bonds,” Varghese said. “The proof was in the pudding last year, with commodities and several alternative strategies seeing positive returns even as stocks and bonds were negative.”
Alternative investments can be affected too.
“Investments like hedge funds and other private capital offerings still face similar pitfalls as investing in companies, although there are some alternative investments that have may some advantages as they are usually subject to what the market for its offering may bear, like real estate, private debt, art, and collectibles,” Johnson said.
Advantages/Disadvantages
Alternative investments provide access to parts of the economy and markets that public-traded equities and fixed income don’t typically give you. Most alternatives tend to be non-correlated to traditional asset classes, which offers a portfolio much better for diversification.
The advantage of private equity is the potential to outperform public market asset classes in certain areas. There is also potential for less perceived volatility because those private investments do not trade with as much volume on a public exchange. Private investments do not price as frequently, so the price has less fluctuation.
With the possibility for outperformance, there are also clear disadvantages to alternatives such as a lack of transparency, low liquidity, high minimum thresholds, low tax efficiency, higher fees, and potential for higher risk in a concentrated format.
“When considering alternative investments, it’s very important to look at the time horizon along with the income needs to make sure those investments are strategically aligned with a well-thought-out financial plan,” Swartz said.
Many alternative investments — like private equity, private credit, and real estate — are not mark-to-market on a continuous basis, like publicly traded securities. They have the feature of being less “volatile,” at least on the surface.
“That helps investors stick to these investments more than they typically would if market values were swinging wildly day after day,” Varghese said. “The most obvious disadvantages are that they are illiquid and typically more expensive. That said, we believe alternative investments should be long-term strategic allocations within a portfolio.”
“Alternative investments are not typically correlated with the stock market, therefore they are a good tool to diversify a portfolio,” Johnson said. “This adds asset classes that aren’t traditional to investment portfolios. They may include private equity, hedge funds, commodities, precious metals, art, and collectibles. Alternative investments may potentially provide greater returns than the stock market.”
The disadvantage of alternative investments is that they are usually private investments that are not very transparent, complex and highly illiquid. They may be difficult to exit, tying your money up for many months to years. Also, alternative investments are usually available only to accredited investors, and they characteristically have high investment minimums and high fees.
Current Market
Figure out the investment portfolio that most helps you to achieve your short-term and long-term financial goals and ideally matches your risk tolerance.
“From a portfolio construction standpoint, we like to diversify not just across asset classes, but also managers, methodologies, tax-efficiency, and liquidity profiles,” Varghese said.
“Markets are incredibly resilient and have proven their worth over the past 100 years [but] how one invests must be determined first by their financial plan and goals,” Polking said.
For instance, the investment strategy of a retired executive with significant real estate holdings may be wildly different from a young physician with lots of debt, but that has little to do with the investing climate.
Be resilient while keeping perspective. Downturns are normal. Buying low, dollar-cost averaging and rebalancing your portfolio should always be considerations for continued success.
“No one can predict what markets will do, but historically after larger declines the future expected returns have been higher for the disciplined, long-term, investor,” Swartz said.
The investing outlook depends on whom you ask.
“There will always be folks on both ends of the spectrum, some proposing doom and gloom, others seeing nothing but roses,” Polking said. “The answer is always somewhere in the middle. If the market ends up struggling again similar to 2022, many might perceive that as a ‘bad’ market. But for those long-term savers, depressed prices in the market is simply an opportunity to buy more for the eventual rebound.”
“We believe the economy can avoid a recession this year as the consumer remains strong,” Varghese said. “We think the equity market will rebound as well, with returns potentially in the 12 to 15% range. Fixed income had a very unusual two negative years in a row [2021 and 2022], and so we expect a reversal this year, with most of the return coming from the higher yields fixed income currently offers.”
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