The Perils of Inflation
Even during the best of times, choosing stocks can be a complicated process involving multiple considerations. Though periods of high inflation add another layer of complexity, there are a number of strategies that you can pursue to try and successfully navigate the uncertainty.
Inflation represents an economy-wide rise in prices. It can be caused by either increasing commodity prices and business expenses (cost-push inflation) or driven by rising consumer demand (demand-pull inflation). Regardless of its underlying causes, inflation means that your purchasing power will decrease as the value of your dollars gets diminished.
Whether you are an experienced investor or just getting started, TipRanks has multiple sets of tools to help you on your financial journey.
What are the Implications of High Inflation?
High inflation (which is considered a year-on-year rise in prices of 5% or more) decreases the value of cash. Your money, in essence, will purchase less as your wealth gets eroded.
Even interest-earning investments could be losing money. For instance, if your savings account is providing a 2% return and inflation is 3%, you have effectively lost money. During environments of high inflation, it becomes even more vital to find investment vehicles that can safeguard your wealth.
However, there are a number of investments that can outpace inflation. Rising prices across the board will also drive-up the cost of real estate and commodities, making these good places to park your money. In addition, there are certain bonds that are pegged to the rate of inflation, such as Treasury Inflation Protected Securities, which offer a hedge against an economy-wide rise in prices. (The danger with these TIPS bonds, of course, is that their value can also decrease during periods of deflation.)
Which Stocks Perform Well During Inflation?
Some of the most obvious stocks to pick are those that are intrinsically tied to or based on items whose prices will also increase. For example, utility companies will pass along the cost of energy to their customers, and are therefore relatively shielded from the negative impacts of inflation. Likewise, firms that dabble in commodities will see their prices rise commensurately with the surrounding increases. Beyond individual companies, there are multiple Exchange-Traded Funds (or ETFs) that are comprised of commodity stocks.
Additionally, as mentioned above, real estate is generally a sound investment to help weather the effects of inflation. For those of us lacking the resources to purchase multiple properties, real estate investment trusts (also known as REIT stocks) allow average investors to place their monies in either commercial or residential real estate assets.
Consumer staples and other items of necessity also make sense when inflation is on the rise. Companies peddling necessities like food, pharmaceuticals, and other items considered inelastic (i.e. demand does not change when prices go up or down) are good stock bets to generate value during times of high inflation.
The Worst Stocks to Buy When Inflation Hits
The corollary, it follows, is to avoid stocks that depend on discretionary spending that consumers are more likely to cut back on when times get tough.
This translates to companies who rely on purchases such as trips and vacations (think airplane companies or hotels), luxuries (jewelry), and other items that are more for fun and enjoyment (golf clubs, electronics) than basic living needs (supermarkets, medicines, etc.). In addition, companies purveying goods that tend to be durable should also be avoided (appliances, cars), as individuals concerned about their budgets will be less likely upgrade for shinier options unless it is absolutely necessary.
Conclusion: How to Think About Inflation
High inflation creates an additional impetus to make smart investment decisions that will prevent the erosion of your wealth. Finding good investments in the stock market during periods of high inflation is one strategy to consider.
Though the value of individual stocks ultimately depends on the underlying foundations of the particular company, make sure to consider inflationary pressures and how this might impact the future prospects of your investment.
Learn money management, and use data-driven stock insights with TipRanks.
