Inflation is back - don't I have to do something?
November 15, 2021
When market conditions change, investors often feel compelled to do something. To that end, we can agree on one point: it’s challenging to stand by and watch events transpire. The typical working assumption is: Something I own must be sold; something I don’t own must be bought, because, well, things are going to change. But what if doing nothing is the best thing you can do?
By owning assets that don’t track or exceed inflation, purchasing power diminishes over time. It’s one of the arguments against fixed pensions or fixed payment annuities; as prices continue to move higher, income of that nature is stagnant. While inflation will cause you to need more money to buy gas or bread or to pay for healthcare, a fixed payment doesn’t provide higher income. A fixed pension of X dollars buys considerably less 10 or 20 years after it started, even if inflation is relatively tame.
From a historical perspective, one of the main benefits of owning equities is their value increases over time. It’s the reason why we use a bucket approach when investing client funds; less volatile assets are used for short-duration cash needs, while more volatile investments (e.g., equities) are invested to grow over time. So, what needs to change when inflation rears its ugly head?
Writing in the Wall Street Journal1, Jason Zweig notes that “Taking on more risk to fight rising prices can do more harm than good.” Examples of taking on more risk include flocking to buy Bitcoin, gold, energy stocks, or commodities without understanding what is being bought or whether or not what you’re buying is truly an inflation hedge.
Zweig quotes Savina Rizova, the head of research at Dimensional Fund Advisors, who notes that energy stocks and commodities “are not effective hedges against inflation. That’s a big myth out there.”
As Zweig notes, “the stock market overall has outpaced moderate rises in the cost of living. From 1927 through 2020…U.S. stocks as a whole outperformed inflation by an average of 4.9 percentage points annually in years when rises in the cost of living were above the median.” He adds: “If your stock portfolio is already well diversified, it should be able to keep pace with modestly rising prices.” (See chart below.)
Source: Dimensional Fund Advisors
1 Zweig, Jason. “Deflating Your Inflation Fears.” The Wall Street Journal, 29 Oct. 2021.
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