Investment Corner: How Does Inflation Impact Investing Strategy?
Two years ago, I was writing about the high inflation of 2022 and 2023. Right around that time inflation started dropping dramatically, all the way to where it sits now—below 3%. Meanwhile, interest rates have not dropped, and are holding at rates substantially higher than we saw just a few years ago. The 10-year treasury rate is sitting at 4.4%, compared to 1.6% at the beginning of 2022.
All of this means that—for the moment—you can actually find money market funds and CDs that are paying interest rates above the rate of inflation! As an example, Schwab’s Treasury Obligations Money Market Fund (SNOXX) paid a 7-day yield equivalent of 4.00% as of June 13th. That’s a full percentage point—or more– than the current rate of inflation!
However, operating on the assumption that this will continue would be like assuming that because our lake here in Tahoe is now full, it will remain full. We’ve all been around long enough to watch the cycles of snow and drought that see the lake lower, and then fill, and then lower again. It was just a few years ago that we saw boats getting beached hundreds of feet out from shore due to the low water level in the lake.
Similarly, don’t be fooled into thinking that these safe investment rates will always outpace inflation. Money invested in CDs and money markets often loses buying power due to inflation. Unsatisfyingly, it can be very hard to predict when this change might occur.
Many economists are projecting that any new tariffs will cause some inflation. At the same time, consensus projections for interest rates suggest the possibility that the Fed will cut rates sometime this year. If those two things were to happen, we could very quickly be back in an environment where CDs and money market funds can’t keep up, and those sorts of cash-equivalent assets are losing value.
So, what is a smart investor to do? For starters, don’t do anything rash! If you’ve built a portfolio that makes sense for your timeframe, goals and risk tolerance, you shouldn’t need to make major changes. Some smaller tweaks around the edges may make sense, depending on your situation.
If interest rates do fall and you need less-volatile assets, it is more advantageous to hold bonds than to hold cash. Remember, bonds go up in value as interest rates fall. Cash, on the other hand, brings a lower rate of return when interest rates fall. Of course, nobody knows what happens next, and if inflation does increase it’s quite likely that interest rates will eventually follow higher. To hedge against this possibility, you could consider keeping your bond holdings to a shorter-duration, so that there is less volatility when rates change. If rates do spike higher in the future, it might be an opportunity to trade in those short-term bonds for some longer-term ones to lock in those higher rates.
A diversified equity (stock) portfolio is arguably your best chance of beating inflation over the long run. With average annual returns, per Investopedia, of approximately 10% before inflation (assuming reinvestment of dividends) for the S&P 500 Index over nearly 100 years, there have been very few 10-year periods when stocks did not outperform inflation. Adjusting the amount of equities in your portfolio depending on your timeframe, goals and risk tolerance remains critical, so make sure that you still have appropriate amounts of bonds, cash, and possibly real estate and commodities as well for balance.
Like the lake, financial conditions are always changing—but with the right preparation, you can stay afloat for all seasons.
Whatever route you take to deal with inflation, invest smart and invest well!
Larry Sidney is a Zephyr Cove-based Investment Advisor Representative. Information is found at https://palisadeinvestments.com/ or by calling 775-299-4600 x702. This is not a solicitation to buy or sell securities. Clients may hold positions mentioned in this article. Returns are not guaranteed and past performance does not guarantee future results. Consult your financial advisor before purchasing any security.
