Prepare Now For Inflation (Before It’s Too Late)
The U.S. House last weekend approved a $1.9 trillion pandemic relief bill that would send cash to individuals, businesses, and state and local governments to counteract the economic damage wrought by the COVID-19 pandemic.
The legislation still needs to clear the Senate, but as it currently stands it provides a rebate that amounts to $1,400 for a single taxpayer, or $2,800 for a married couple filing jointly (and another $1,400 per dependent). The checks would begin to phase out for individuals earning more than $75,000 annually and married couples earning over $150,000.
Last year’s stimulus is widely credited with helping to pull the stock market out of the bear market that started in March 2020. People with extra money tend to spend that money, and that helps stimulate the economy. It also helps create a more positive future outlook for the markets.
However, there is a potential downside to this kind of government spending: inflation. More pundits are talking about the prospect for an uptick in inflation this year, and that can have a detrimental impact on your portfolio.
How can stimulus spur inflation? Let’s do a simple thought experiment. Imagine the U.S. government gave everyone a million dollars. Ignoring the obvious budget deficit issues that would create, what would happen?
There would be a massive spending spree. People would buy cars, homes, boats, and all sorts of luxury items. In fact, demand for these items would be so great that supplies would have a difficult time keeping up with demand. That, in turn, would drive prices higher.
Indeed, bond yields have been climbing as Wall Street increasingly worries about inflation. Rising yields have in turn weighed on stocks.
The same inflationary dynamic occurs if you give everyone $1,400. People who usually don’t have extra money to spend will buy all sorts of things. My brother works for the U.S. Postal Service. He told me that after last year’s stimulus checks went out, you would have thought it was Christmas judging by the number of items people were receiving in the mail.
A little inflation is a sign of a healthy economy. The Federal Reserve has targeted a long-term inflation rate of 2%. That means that each year, the goods and services we buy cost about 2% more than they did the year before.
If your salary is increasing by 2% or more each year, at least that is keeping up with inflation. But if you have money parked in a savings account earning 0.1% interest, then it is losing about 2% of its purchasing power each year.
So your goal, at a minimum, is to stay ahead of inflation. And if inflation heats up, your returns need to improve or you will lose purchasing power at a faster rate. If your money is parked in a low- or no-interest savings account, in 10 years it can lose 20% of its purchasing power even in a low-inflation environment.
So, what should you do as an investor? You should have at least a portion of your portfolio in inflation hedges. These are assets that perform well in an inflationary environment. Some examples are gold, real estate, and commodities. A popular option for more risk-averse investors is Treasury inflation-protected securities (TIPS), which are U.S. Treasury bonds that are indexed to inflation.
Finally, certain stock sectors are better for protecting against inflation. Some examples are the sectors that make the goods that are in high demand, and hence helping to drive inflation, or that provide the raw materials for these sectors. Popular inflation hedges include real estate investment trusts (REITs), gold stocks, energy stocks, and basic materials.
Just remember, over the long haul, the worst thing you can do to protect against inflation is nothing. Leaving your money in a low-interest account is a long-term losing strategy.
Editor’s Note: Our colleague Robert Rapier just provided you with commonsense investment advice. You should also consider the advice of another expert on our staff: Amber Hestla, chief investment strategist of the trading services Income Trader, Profit Amplifier, Maximum Income, and Precision Pot Trader.
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