Since reaching its 40-year peak in the United States three years ago—and after rising substantially in over 44 countries—inflation has been slowing down.
The International Monetary Fund (IMF) reported that global recovery is “slow and steady,” with global inflation declining steadily.
However, this does not necessarily mean that price levels will go down. In fact, the country’s Consumer Price Index (CPI) reached an all-time high in May 2024.
The impact of inflation makes it difficult for consumers, businesses, and investors to prioritize spending. The cost of living and the price of goods are high, and basic necessities such as rent, food, clothes, and gas are much more expensive.
With higher prices, your money doesn’t go as far, particularly on investments producing fixed returns, like bonds and savings accounts. The threat of higher interest rates can also make it difficult for you to see a steady cash flow from your investments.
But this inflationary environment can also be a time for certain investments to shine. Some can help you hedge against inflation and keep rising prices from drastically affecting your investment portfolios.
Investment decisions considering inflation-resilient asset allocations can help you spread your risk through diversification.
In this post, we’ll cover which investments and asset classes are generally affected by increased inflation and how a diversified portfolio can help you be resilient during economic decline.
What Is Inflation?
Inflation is a rise in prices for a diverse range of goods and services over a specific period, translating into a decline in purchasing power.
It is expressed as a percentage of the price change from the previous year. When purchasing power increases due to falling prices, the result is called deflation.
To best understand inflation, compare the current price of a commonly used item with its price from a few years or decades ago. In the U.S., for instance, the average cost of a burger in 1978 was about $0.64. In 2024, that $0.64 would have the same buying power as $3.22. For $3 in the 70s, you could’ve bought almost five burgers versus only one in 2024.
Economists measure these changes in the cost of goods and services over a year, showing how broadly prices fluctuate. Over time, inflation decreases the currency’s value because the same amount of money can purchase fewer goods, utilities, and services.
The decreasing rate of purchasing power is often reflected in the average price increase of consumer goods.
However, inflation isn’t limited to a specific item or service. It impacts prices across all sectors of the economy and can affect each sector differently.
What Causes Inflation?
Inflation is a complex economic concern with many changing variables. Several economic factors can contribute to, and even compound, the effects of inflation.
Production costs
When the cost of raw materials increases, production costs rise. And when labor costs more for businesses, they raise the price of the goods and services they offer, which leads to a higher rate of inflation (also known as wage-push inflation).
Cost-push inflation prompts manufacturers and producers to pass added costs on to consumers through price hikes in their goods and services.
Consumer demand
When consumer demand for a specific product or service suddenly increases, businesses and suppliers sometimes can’t keep up.
This demand-pull inflation results in a decrease in supply alongside an increase in prices. Some economists describe this as “too many dollars chasing too few goods.”
Expansionary policies
Governmental fiscal policies can increase discretionary income for businesses and consumers. Increasing the minimum wage, investing in infrastructure, and cutting taxes can give companies and individuals more spending money—raising demand and leading to price hikes.
Inflation expectations
Inflation can create a cycle where expectations of rising prices lead to actual increases, as businesses and consumers adjust their behavior accordingly. For example, if workers ask for higher wages, anticipating inflation increases, companies usually respond by increasing their prices.
Businesses may also raise prices if they expect higher cost of goods, i.e., raw materials.
Devaluation of currency
Devaluation occurs when one currency becomes worth less relative to another. For example, the dollar has devalued if the exchange rate used to be $1 to £0.83, but now $1 only buys £0.75.
It can make importing goods and materials more expensive, which then causes businesses to raise prices to cover the increased expenses.
Rising wages
Some experts see rising wages as a contributor to inflation. As workers earn more money, they have higher disposable income and thus are willing to pay more for goods and services. This usually causes increased demand, which leads businesses to raise prices to cover labor costs and increase production.
However, not all economists agree, as past wage increases haven’t indicated a strong correlation with inflation. Additionally, businesses may see increased productivity, preventing demand from outpacing supply.
How Does Inflation Affect Investments?
Rising inflation can negatively affect many kinds of investment strategies. The inflation rate will determine how quickly the real value of an investment is eroded and how much purchasing power is lost at a certain point in time.
Some fixed-income investment prices tend to fall as inflation rises. For example, investors typically buy bonds or treasuries with fixed interest rates (thus remaining unchanged through the years). The longer that rate is locked in, the more vulnerable the price is to inflation changes over time. Because of this, bond prices tend to fall during periods of high inflation.
Inflation affects stocks differently, though it can still be an uncertain period for investors. Inflation makes it more challenging for them to assess a company’s future profitability or how it will handle growing production costs.
Growth stocks also earn most of their future cash flow, making them more vulnerable to inflation.
All this said, some investments make better hedges against inflation—and a higher rate of return—than others. Knowing the investments impacted by an inflationary environment guides investors as to where to put their money during periods of rising costs.
Investments Impacted by Inflation
Because inflation can quickly become a widespread issue across many or all sectors of the economy, it’s critical for investors to know which investments have been historically impacted by inflation rates and to avoid them until prices decrease.
1. Long-Term Bonds
Bonds are subject to interest rate and inflation risk.
Bond prices are inversely related to interest rates, which means as interest rates rise, the prices of a bond will fall, and vice-versa. The real face value of bonds is also eroded by inflation, especially in longer-maturity debts.
For instance, if a long-term bond pays a 4% yield and inflation has a 3% rate, the bond’s real return becomes 1%. This is pure buying power for investors since their bond pays a fixed coupon, which translates into a fixed dollar amount.
Essentially, the higher the interest rate, the lower the bond price, and the higher the bond’s yield will rise across the yield curve. This is because bond prices and yields move in opposite directions, so investors will demand a higher yield to combat inflation.
Ultimately, the way bonds are structured can mean a lower value for your long-term, fixed-income investment.
Inflation and higher interest rates can significantly impact other fixed-income financial assets and decrease the value of certain assets and commodities. Because interest payments on existing fixed-income assets tend to be less competitive compared to newer, high-rate assets, the prices of the existing assets will usually decline.
The inverse relationship between fixed-income asset prices and interest rates can become a headache for investors during economic troubles like inflationary periods.
High prices and inflation rates can reduce the returns on many financial assets that rely on fixed payments, such as bonds, making it even more difficult to improve cash flow.
If you still want to invest but want to take some risk off the table, diversifying your assets and investment portfolio may help you maintain a steadier cash flow during volatile times. Seeking the viewpoint of experienced financial advisors can also lend fresh eyes during what can easily be felt as a tumultuous period.
2. Small-Cap Stocks
Small-cap stocks are the stocks of companies that have a lower market capitalization. As a result, these stocks tend to be more economically sensitive and, therefore, could be affected more by an economic downswing.
During inflation, where prices are higher and some goods and materials are scarce, small caps are subject to significant inflows and outflows, creating uncertainty for your investment.
Since small-cap stocks are usually more economically vulnerable and present a riskier ride for investors, they tend to do worse when external pressures, such as rising prices and decreased value, are placed upon the economy.
Though some small-cap stocks may be more dynamic and adapt to changes more quickly than some large-cap stocks, most companies will experience some form of this impact during an inflationary period.
Generally, investing in small-cap stocks may not be your best short-term bet until inflation declines, when they tend to perform much better.
3. Large-Cap Stocks
As with small-cap stocks, large-cap stock investments have the potential to be risky during inflation. Because large-cap stocks do not necessarily increase with inflation, they may not be ideal for investors who want a quick buy-and-sell transaction.
While large-cap stocks may be less volatile than other stocks, they can still experience periods of high volatility, which means investors can’t assume their money is entirely stable. Lastly, large-cap investments are unlikely to outperform the stock market regularly because of their “slow and steady” characteristics. This means the dividend value is more likely to be eroded by inflation.
Inflation Hedge Investments
When investors search for ways to make money during inflation, one solution is to invest in vehicles that will likely benefit from inflation. These investments could provide greater protection against market volatility and inflation rates.
1. Gold
Gold is one asset considered a hedge against rising costs because some investors flock to it during periods of inflation. Many people consider gold an alternative currency because it is still used when a country’s native currency loses value.
Although the linear relationship between gold prices and inflation is inconclusive, gold prices aren’t as susceptible to the fluctuations other assets experience.
Gold protects against inflation over decades of ownership in the long term. The value of inflation hedging by holding on to physical assets like gold rather than holding onto assets that pay yields depends on the investor’s goals.
As with every other investment, gold prices also fluctuate yearly. Gold investors must also consider the logistics of securing their gold.
2. Real Estate
Real estate income earned from renting out properties can be another good hedge against inflation because real estate rental income tends to keep up with rising inflation rates.
Investors in residential real estate can significantly benefit from inflation due to its resilient demand. As a result, rising interest rates often coincide with rent increases. Average apartment rent across the U.S. has steadily increased for the past several years.
Although a real estate investor’s expenses, such as insurance, will likely also rise during inflation, income-producing real estate still tends to produce higher rental income.
3. Treasury Inflation-Protected Securities
Treasury inflation-protected securities (TIPS) are effective protection against inflation backed by the U.S. government. As costs rise, the price of a TIPS adjusts to maintain its real value.
Inflation leads to a higher principal of a TIPS, while deflation leads to a lower principal. TIPS pays interest twice a year at a fixed rate. Upon maturation, the owner receives the original principal back and may receive a higher adjusted principal.
Investors in TIPS can hold them until they mature or sell them beforehand. TIPS provide government-backed inflation security, making them ideal for inflation hedging. However, these investments usually pay lower interest rates than other securities.
4. Short-Term Bonds
Short-term or floating-rate bonds may be safe to invest in during inflation since their interest rates are indexed to a benchmark, potentially making them less vulnerable to market fluctuations like inflation. Short-term bonds are also more resilient against rising interest rates than long-term bonds. If interest rates rise quickly, these investments will be less affected because they are shorter-term.
Since short-term bonds involve lower interest rate risk, they also tend to yield lower returns. Yet investors looking for protection against inflation may find these investments provide the stability they need during inflation.
5. Other Short-Term Investments: Money Markets, CDs and Commercial Paper
Many people also overlook the value of investing in money markets, certificates of deposit (CDs), and commercial paper during inflation. Money markets are mutual funds that invest in highly liquid instruments, including CDs and commercial paper. These investments have short-term maturity, making them less vulnerable to changing interest rates.
The financial instruments investors can invest in through money market funds are less volatile than many other investments. For instance, CD rates have recently dropped but may still outpace inflation rates, depending on how high a yield the CD rate offers.
Thrive Despite Inflation with 1031 Crowdfunding
Navigating inflation is no easy task, and defending your finances from inflation can be challenging. Investing in assets that hedge against inflation can be an effective wealth management strategy during these periods.
Income-generating real estate, such as business and investment properties, may help you spread the risk amidst inflation. With 1031 Crowdfunding, investors can explore alternative investment opportunities that are not correlated to the volatility of the stock market.
We facilitate real estate investments and alternative investment vehicles. Our management team has performed a total of $3.4 billion in real estate transactions and has the experience to navigate various real estate investment situations.
If you’re uncertain about your investment strategy, our experts are here to assist you. We provide personalized advice to help you make well-informed decisions that align with your goals and optimize your investment opportunities. Register for an account today to learn more about your options or visit our education center online.
This material does not constitute an offer to sell or a solicitation of an offer to buy any security. An offer can only be made by a prospectus that contains more complete information on risks, management fees and other expenses. This literature must be accompanied by, and read in conjunction with, a prospectus or private placement memorandum to fully understand the implications and risks of the offering of securities to which it relates. As with all investing, investing in private placements is speculative in nature and involves a degree of risk, including loss of your principal. Past performance is not necessarily indicative of future results and forward-looking statements and projections are not guaranteed to achieve the results described and your actual returns may vary significantly. Investments in private placements are illiquid in nature and there may be no secondary market or ability to sell the investment should the need for liquidity arise. This material should not be construed as tax advice and you should consult with your tax advisor as individual tax situations will vary. Securities offered through Capulent, LLC Member FINRA, SIPC.
