How Your Advisor Takes Inflation into Account When Creating Your Portfolio
Inflation is clearly on investors’ minds – and for good reason. Many are concerned that recent price hikes could make it increasingly difficult to reach their personal financial goals. While nobody has a crystal ball that accurately predicts what future inflation will be, you can find solace knowing your financial advisor considers inflation in several ways when designing your portfolio.
Once your goal is determined, your advisor can allocate your assets to each goal and ensure the allocations are linked to your personal objectives.
Investors with a goal of striving to outpace inflation are those who do not intend to spend the assets in their portfolios for many years. An advisor factors this in by allocating your portfolio to globally diversified stocks and bonds. Recent research from Dimensional Fund Advisors (DFA) shows this strategy can potentially aid in outpacing inflation when the assets remain invested over the long term. Even when we go back to 1927, including time periods of double-digit inflation, history demonstrates that stocks outperform inflation in the long term. DFA also studied 23 different U.S. assets (stocks, bonds, industries, and equity premiums) in high inflation years and concluded that all assets, except one-month Treasury Bills, had positive average real returns. Depending on one’s financial plan, an advisor can increase the allocation to stocks that exhibit higher expected real returns. Keep in mind this strategy involves taking on increased market risk and may not be suitable for all investors.
Some investors are especially sensitive to unexpected inflation and might want to hedge against this risk. An advisor considers this by allocating a portion of the portfolio to inflation-indexed securities, like Treasury Inflation-Protected Securities (TIPS) or alternative asset classes expected to benefit from higher inflation. TIPS, which are linked to the Consumer Price Index, are historically the most effective hedge. TIPS can protect purchasing power from being diminished because investors owning TIPS will receive compensation if inflation rises more than expected.
Alternative assets like Real Assets and Trend Following can also act as diversified beneficiaries of inflation with low correlations to stocks and bonds. Real Assets, such as farmland, timberland, and infrastructure, tend to see increases in prices as inflation increases. The goal of trend following, on the other hand, is to strategically allow investors to profit in both bull and bear markets by positioning the portfolio to capture the upward trending price movements that may occur during inflationary periods in assets such as commodities or global stocks (or vice versa when certain global assets may be trending down in price).
Although it might seem like investors are being bombarded nearly every day with headlines that scream “Inflation!”, it is worth noting that decisions regarding portfolio design should not be made based on these headlines alone. Qualified advisors know which tools can be harnessed to help lessen the complex effects inflation might have on a portfolio. An advisor will also ensure allocations are aligned with a client’s personal financial goals and objectives.
Investors are always going to experience unwelcome or unexpected financial events, but the good news is that your advisor takes many things into consideration, including inflation, when creating your portfolio.
Indices are unmanaged, do not reflect fees and expenses, and are not available as direct investments. Returns are calculated in U.S. dollars and reflect the reinvestment of dividends and other earnings.