Inflation and deflation These are economic factors that investors should consider when planning and managing their portfolios. The two trends are opposite sides of the same coin: Inflation It is defined as the rate of increase in prices of goods and services; deflation It is a measure of the general decline in prices of goods and services. No matter what trend is in motion, the steps investors can take to protect their assets are clear; but the economy can move quickly from one to another, making it difficult to discern the right steps.

What to Expect in Times of Inflation?

Over time, the prices of everything from a loaf of bread to a haircut to a home tend to increase. When these increases become excessive, consumers and investors may face difficulties. purchasing power will fall rapidly. A dollar (or whatever currency you’re dealing with) buys less; this means it is inherently less valuable.

A clear example of rising inflation occurred in the United States in the 1970s. The decade began with inflation in the mid-single digits. By 1974, this rate had risen to over 11%. After a decline, it rose again to over 11 percent in 1979 and peaked at around 13.5 percent in 1980. In an environment where investors were earning mid-single-digit returns on stocks and inflation was double that figure, making money in the market was a difficult task.

Protecting Your Portfolio from Inflation

There are several popular strategies for: protecting your portfolio From the ravages of inflation.

First and foremost exchange. “Stagflation” of the 70s aside, rising prices tend to be good news for stocks. Growth stocks are growing along with a swelling economy.

For fixed income investors looking for an income stream that can keep up with rising prices, Treasury Inflation Protected Securities (TIPS) It is a common choice. These government-issued bonds come with a guarantee that their nominal value will increase with inflation. Consumer Price IndexInterest rates will remain constant. TIPS interest is paid semi-annually. These bonds can be purchased directly from the government. Treasury Direct The system is offered in five, 10 and 30-year terms in $100 increments with a minimum investment of $100.

international bonds It also provides a way to generate income. They also provide diversification by allowing investors to access countries that may not face inflation.

Gold is another popular inflation protectionSince it tends to maintain or increase its value during periods of inflation. Other commodities, such as real estate, may also fit into this bucket, as the value of these investments tends to increase when inflation is on the rise. On the commodity side, emerging market countries generally generate significant revenues from commodity exports; so adding stocks from these countries to your portfolio is another way to play the commodity card.

What to Expect in Times of Deflation?

Deflation is less common than inflation. It may reflect an abundance of goods or services in the market. This also occurs when a low level of demand in the economy leads to an extreme drop in prices: Periods of high unemployment and economic depression often coincide with deflation.

of japan lost decade It draws attention to the devastation of deflation (the period between 1991 and 2001). The period began with crashes in both the stock market and the real estate market. This economic collapse caused wages to fall. Falling wages caused demand to decrease, which in turn caused prices to fall. Low prices led to the expectation that prices would continue to fall, and consumers delayed purchasing. Lack of demand caused prices to fall even further, and the decline continued. Combine this with interest rates hovering near zero, the yen devaluing, and economic growth coming to a halt.

Protecting Your Portfolio from Deflation

When deflation is a threat, investors become defensive by opting for bonds. High-quality bonds outperform stocks during periods of deflation; This points to the popularity of government-issued debt and AAA-rated corporate bonds.

On the stock side, companies that produce consumer goods that people need to buy no matter what (like toilet paper, food, medicine) tend to survive better than other companies. These are often referred to as: defensive stocks. Dividend-paying stocks are another consideration in the equity arena.

Cash is also becoming a more popular holding. In addition to plain old savings accounts and interest-bearing checking accounts, as well as cash equivalents: Certificates of deposit (CDs) and money market accounts – assets that are highly liquid.

Planning for Both Inflation and Deflation

Sometimes it’s hard to tell whether inflation or deflation is the bigger threat. When you can’t tell what to do, plan both. A. diversified portfolio Investments that include investments that thrive during inflationary periods and investments that thrive during deflationary periods can provide some protection no matter what happens in the economy.

Diversification is key when you don’t have the incentive to try to time the inflation/deflation cycle correctly. Blue chip companies tend to have the strength to weather deflation and they also pay dividends, which helps inflation to the point where it rises. valuations stagnant.

Diversifying abroad is another strategy. emerging markets They are mostly exporters of goods in demand (hedge against inflation) and are not perfectly linked to the domestic economy (hedge against deflation). High-quality bonds and the TIPS mentioned above are reasonable choices on the fixed income side. With TIPS, you are guaranteed to get back at least the value of your original investment.

Time horizon also plays an important role. If you have 20 years to invest, you probably have time to weather any crisis. If you’re close to retirement or living off the income your portfolio produces, you may not have the option of waiting for a recovery and little choice but to take immediate action to adjust your portfolio.