You’ve probably noticed that the price of everything is going up—everything from gas at the pump to eggs at the grocery store. How do these price increases impact your investments? The answer depends on what those investments are.

How Does Inflation Affect Investments?

1. Savings Accounts Shrink
2. Real Estate Becomes More Valuable
3. Stock Investments Vary
4. Bond Returns Slow Down
5. Precious Metals Skyrocket
6. Raw Material Prices Increase
7. Mutual Funds Depend on the Securities They Hold
8. Crypto is Unpredictable

First, a brief explanation of inflation: inflation is when the purchasing power of each and every dollar decreases; not necessarily that the dollar itself loses value. Economists debate the causes of inflation, but a common consensus revolves around that basic law of supply and demand: if there is too much money in the economy, people want more goods and services, leading to shortages of those goods and services. This, in turn, leads to price increases.

Inflation can also be caused by the increased cost of moving unfinished products along the supply chain until it arrives in the hands of consumers. With disruptions caused by the Covid Pandemic and increasing fuel prices, the cost of production has also gone up, leading to higher sticker prices at the store.

How Does Inflation Affect Me?

As interesting as that all might be, these implications can cause a real issue for the average consumer. Suddenly eggs, milk, and bread have prices that are higher than before. When that effect is multiplied across a wide variety of items, consumers are forced to make difficult choices, and at the very least put aside discretionary spending on things like movies, dining out, and vacations.

One metric of inflation is the consumer price index (CPI), which tracks the price movement of specific goods and services that consumers typically buy (such as the aforementioned eggs, milk, and bread). When the CPI rises to alarming levels, day-to-day life becomes a bit of a squeeze for consumers who were previously living more comfortably.

This inflation can also affect consumer investments. Some types of investments fair well in an inflationary environment, while others plummet.

How Does Inflation Affect Investments?

If you’re looking to protect your investments from the squeeze of inflation, consider how each asset typically performs under less-than-ideal economic conditions and adjust your investment strategy accordingly.

1. Savings Accounts Shrink

A savings account is a staple among low-risk investments. Unfortunately, savings accounts no longer pay a great interest rate, so the reward for the low-risk factor is pretty negligible. Although it is a decent place to keep money, to avoid spending it.

The truth is that savings accounts don’t actually shrink during inflation. But if the inflation rate is 10 percent (as it is at the time of this article), that essentially means the money you’re hiding under your proverbial mattress has 10 percent less purchasing power—which means your savings account, in essence, is shrinking, even if the money is not literally disappearing.

2. Real Estate Becomes More Valuable

There is a silver lining to every cloud, as they say. Inflation causes an increase in goods and services, and housing is no exception. Rising housing market prices are very common during inflation, which is not good if you are in the market to purchase a new home, which you will either have to delay or bite the bullet and spend more.

However, these rising prices are good if you are selling a home. In fact, if you’ve been contemplating a move to something more affordable or to a lower-cost-of-living location, now might be the time to list your home on the market. Just keep in mind that the value of homes where you want to live might also be on the rise. In any case, the accumulated wealth that makes up your personal net worth may see gains from the increase in property value.

3. Stock Investments Vary

Some stocks will go up, while others will go down. Remember that during inflationary periods, consumers have less discretionary cash to spend on dining out, travel, and entertainment. Companies like cruise ships, airlines, hotels, and restaurant chains may report less-than-desirable earnings, which in turn brings down their prices.

By contrast, companies that have a captive audience selling consumer staples (food, pharmaceuticals, energy, telecom) are going to remain fairly stable and may even see an increase in stock value. These companies will just raise the price of their goods and services to make sure that shareholders are still getting returns and dividends, which bodes well for anyone holding stock.

If inflation does some good for your portfolio, you may be tempted to sell off some of your securities to cover expenses that have become difficult to manage with the declining purchasing power of the dollars in your checking or savings accounts. This is something you’ll want to discuss with a competent financial professional who understands the federal income tax implications of such a move. Consider scheduling a free strategy session with an Anderson Business Advisor to talk about the best way to accomplish this.

4. Bond Returns Slow Down

Inflation is not good for every security. It can negatively impact the return on existing bonds or treasury notes. Bonds are typically fixed-rate investments, so that means if inflation begins to eat away at the potential return, there is no way they can grow out of that.

There is one type of bond that does well during inflation, and that is the Treasury Inflation-Protected Security (TIPS). TIPS have a price value tied to indexes that track inflation. So, if inflation increases, so does the value of the TIP and its interest payments. For these reasons, TIPS can be a great way to hedge against inflation for retail inventors.

5. How Inflation affects Precious Metals Skyrocket

In times past, each dollar was connected to real, tangible precious metals, like gold. There was some currency in exchange that was actual silver, like the Kennedy Dollar. In any case, that is no longer the case. However, gold and silver are still in existence, and the investment allure is still alive and well.

In addition to the fact that gold and silver have been used as currency for thousands of years, they are also used in jewelry and electronics. So, they still have inherent value. When the purchasing value of the dollar declines, more dollars are needed to purchase the same amount of gold—meaning that the dollar value of gold has increased.

Some people begin to purchase gold during insatiable economic times, further driving up the price. This can lead to precious metals skyrocketing during inflationary periods. This inverse relationship with the US dollar and its own inherent allure and value are two reasons why many investors hold onto gold as a long-term investment, especially to provide balance and security as short-term investments fluctuate.

6. Raw Material Prices Increase

Raw materials, like oil, lumber, and food, aren’t typically things the average consumer is invested in. These items are usually part of an assembled product, or in some cases, sold directly to consumers. Either way, they are referred to as commodities and are sold on the commodities market.

Commodities are extremely volatile, even more so than stocks. For this reason, retail investors are often discouraged from participating in commodities. However, if you have a trading app or online brokerage account that allows you to buy and sell ETFs linked to commodities, this could be your chance to participate in great returns.

7. Mutual Funds Depend on the Securities They Hold

Mutual funds represent a diversified basket of investments that are actively managed by a team of financial advisors or a money manager. These individuals are licensed and competent at navigating strategies that go beyond buying and selling stocks, such as options contracts and short selling.

During inflationary periods, they can use these strategies to compensate for losses sustained by other parts of the portfolio. They can also rebalance the portfolio to unload stocks that will not fare so well, while picking up others that will. For these reasons, many consumers will find that investing in mutual funds yields a consistently safe return during all types of economic climates.

Whether or not your mutual fund increases in value will depend on what type of investments are in the fund. So during an inflationary period, if it is bond-heavy, inflation might do more damage. If it is heavy in consumer staple stocks, inflation might increase its value.

8. Crypto is Unpredictable

Cryptocurrency, also known as digital coinage, is a relatively recent investment, and one that is still very unregulated. This means that it has a lot of volatility, no matter the economic landscape. And because it’s so new, there is no way to predict a cryptocurrency’s future results, making it a greater risk.

For these reasons, it’s hard to say if inflation directly impacts the crypto market. One can assume that consumers faced with a declining dollar may be tempted to put their wealth into cash alternatives, and crypto is alluring because there is no central bank or federal reserve to create restrictive policies. This in turn can drive up the price of crypto, along with other lines of supply and demand.

Keep in mind that crypto is a generic term referring to the general marketplace of digital coins. There are thousands of different digital coins or cryptocurrencies, and whether some of them rise or fall in value may or may not be linked to inflation, among a myriad of other factors that are difficult to track.

High Inflation Doesn’t Mean Your Investments are Doomed

In summary, this is how inflation affects your investments. Higher inflation rates can certainly have a negative impact on consumer spending and purchasing power. However, high inflation can also mean a higher return for certain investments, like real estate, stocks tied to consumer staples, and treasury inflation-protected securities.

For other assets, rising inflation can create market conditions that lead to lower returns, presenting a more significant investment risk, like in the case of consumer discretionary stocks or traditional bonds.

Any financial professional would advise investors to be prepared to deal with a wide range of investing risks, including inflation risk. The best way to do this is by creating a plan and investing in a wide array of asset classes.

As always, take advantage of our free educational content and every other Tuesday we have Toby’s Tax Tuesday, a great educational series. Our Structure Implementation Series answers your questions about how to structure your business entities to protect you and your assets.

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