The first half of the year is behind us, with the market performance strong across the board. But what about the rest of the year? With inflation on the minds of many investors, how do you protect against those risks, and what top strategies could help better position portfolios?
Inflation is seemingly everywhere, with the prices of oil, lumber, steel and real estate all pushing higher. Some of that inflation could be with us for quite some time. Of particular concern is increases in rents – up over 8% nationwide (opens in new tab) in June to a record high $1,575 per month, according to Realtor.com. Also, rising wages — while good for individuals — can mean higher costs passed on to the consumers.
What can you do to protect yourself from inflation, and how can you ensure your portfolio is keeping up with rising prices?
Investment Adviser Representative of USA Financial Securities. Member FINRA/SIPC A Registered Investment Advisor. CA license # 0G89727 https://brokercheck.finra.org/ (opens in new tab)
1. Don’t Be Too Conservative
Inflationary environments often see asset prices rise, but they can be challenging for the value of bonds. As interest rates rise, the value of your bond portfolio could decrease, potentially eliminating any benefit you are receiving from a consistent yield. In a period of slowly rising interest rates, a traditional bond allocation could mean some dead weight holding back your portfolio from the true upside potential. A portfolio that is too conservative will have a tough time keeping up with inflation.
Conventional financial planning suggests an increasing allocation to bonds as one ages and approaches retirement. For example, if you are 60 years old, maybe you need a 35% allocation to bonds. With interest rates so low and inflation becoming more of a threat – you may want to consider decreasing that bond allocation to optimize performance.
2. Focus on Inflation-Favorable Sectors
Consider increasing your allocation percentages in areas of the market that do well in inflationary environments.
Credit Suisse (opens in new tab) did research on markets where inflation was expected to increase, and which sections of those markets performed best in those times. They found that on an average day if the S&P 500 was expected to increase by 0.45%, the energy sector was expected to increase 0.86%. Two other areas with the potential to outperform include financials, at 0.68%, and materials, at 0.62%.
Increasing your exposure to funds, ETFs or individual stocks in those sectors could help your portfolio keep pace during an inflationary environment.
3. Be More Active and Dynamic in Your Risk Management
Increasing your equity exposure could make sense, but it needs to be coupled with a rule set for managing risk. If you use an adviser, ask them about their strategy for managing volatility. If invested in a fund or ETF, look at how that strategy has weathered prior volatile markets and understand what goes into their methodology for risk management.
If you are buying an individual stock or ETF on your own, set your own price targets. Maybe set trailing stop losses to lock in your gains and limit your downside exposure. A trailing stop loss order lets you set a price to exit a stock that rolls up as the stock increases in value. For example, a 15% trailing stop loss on a $100 stock would initiate a sell of the position at $85, but if that stock rises in value to $115 the trailing stop order will ratchet up the exit sale price to $97.75. You are getting the stock exposure you want but limiting your downside risk if the market moves the other direction.
The key for any investment strategy is to not rely on emotion and to be levelheaded about your strategy. Take advantage of opportunities in the market, but be disciplined in managing your downside exposure.
4. Consider Technology to Diversify
Technology has been a lagging sector since late last year, but it is emerging again as a place of potential growth. Technology had significant outperformance during the COVID year or 2020 but has had weaker performance since then.
As multiple tech companies recently reported strong earnings, an overweight in your allocation to the sector could be appropriate.
Technology is one of those areas that have the potential to profit during inflationary environments. Tech companies may find it easier to pass price increases on to consumers, and their business models may be less susceptible to pricing and supply chain disruptions.
With the Delta COVID variant surging in many parts of the country, the lower risk of business interruption might also be attractive in technology companies.
5. Watch the Federal Reserve
One of the biggest concerns about inflationary pressure is what the Federal Reserve might do in response. Actions the Fed could take include slowing its recent bond purchases or raising interest rates. While the members of the Fed have signaled little change to policy in the short term, continued strong inflationary pressure could cause them to change their minds. And that could put the broader market at risk. Action by the Fed to quell inflation could lead to a pullback, requiring that investors take additional risk-management measures.
6. Adjust Your Expectations
Many investors think about performance on an absolute return basis, but it is important to think about how inflation can impact your financial plans overall. In the short term, does your income need to increase to accommodate the increased costs of goods and services? Does your plan account for inflation, and will your portfolio be able to keep up with rising costs? Now is a good time to re-engage a financial adviser and ask if your plan is aligned with higher inflation expectations. With a 3% annual inflation, like we saw last year, your portfolio needs to do more to keep up.
7. Reassess Your Long-Term Plans
Housing prices were up 24.8% year over year in June, according to Redfin (opens in new tab). If you were considering moving and downsizing, is now the time? The smaller home or community you considered moving to has also likely seen an increase in prices, so beware of potential sticker shock.
Inflation may have a positive impact on your current net worth, as most asset prices have increased. That may give you more flexibility in your plan to reposition or relocate. Just bear in mind that if inflation continues to be an issue, downsizing your real estate might make it more difficult to keep up with inflation as your smaller home may not see as large of an equity increase as a larger home.
8. Consider Purchase Delays Where Appropriate
The inflation that certain areas of the economy are experiencing will likely be temporary, but for others, it may be longer lasting. You may want to consider delaying purchases of goods or services that are temporarily priced higher due to supply disruption. For example, you might want to delay a home addition because of higher lumber costs, or delay the purchase of a used car as those areas of the market have seen supply chain issues. Similarly, travel to certain areas is in higher demand now, leading to possible price increases. Delay can work as a tactic if you believe price increases in that area are temporary.
In summary, inflation is the biggest story going into the second half of the year. Investors need to be aware of the opportunities and risks of navigating during an inflationary environment.
Investing carries an inherent element of risk, and it is possible to lose principal and interest when investing in securities. Strategies are used to assist in the management of your account. Even with these strategies applied to the account, it is possible to lose money. No strategy can guarantee a profit or prevent against a loss. There may be times when the strategy switches between equities or fixed income at an inopportune time, causing the account to forfeit potential gains. USA Financial Exchange is an SEC-Registered Investment Advisor. SEC Registration does not imply a certain level of skill or training.
Scot Landborg has over 17 years of experience advising clients on retirement planning strategies. Scot is CEO and Senior Wealth Adviser for Sterling Wealth Partners (opens in new tab). He is host of the retirement planning podcast Retire Eyes Wide Open. Scot is a regular contributor to Kiplinger.com and has been quoted in "U.S. News & World Report," Market Watch, Yahoo Finance, Nasdaq and Investopedia. He also formally hosted the nationally syndicated radio show "Smart Money Talk Radio."
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