It’s no secret at this point — inflation continues to be a big issue for American consumers. The inflation rate year-over-year for March 2023 was 5% — and this is actually a bit of a dip, with inflation rates for the previous year going as high as 9.1%. This is understandably difficult for many people, as their wages may not be going up, meaning their purchasing power is going down. Many also have concerns about how inflation will impact the market, and by proxy their portfolios. New analysis from Morningstar looks at exactly how inflation will impact Americans’ portfolios, looking at two key historical lessons.
For more help with making sure your portfolio can stand up to inflation, consider working with a financial advisor.
Looking at History
Morningstar compared current market data with data from two other periods in American history where there has been high inflation — between February 1966 and January 1970, and between February 1977 and March 1980. While there is a lot of complicated financial math and analysis you can read in the original article, the gist of the matter is this — in both of these situation, there was a positive correlation between stocks and bonds — meaning that when one went up, the other went up as well. This is not the norm, as generally stocks and bonds correlation of close to zero or a negative correlation.
From November 2000 to 2020, the same general trend continued — stocks and bonds respective values were mostly independent, with some negative correlation. In 2021, though, the correlation moved to the positive side of the ledger, with a correlation coefficient of 0.58 in 2022 and 0.15 for the trailing three year period. For the two historical periods discussed above, the correlations ended up at 0.26 and 0.28, respectively.
What It Means For Your Portfolio
While understanding how the market has responded to past inflationary environments at a macro scale is great, most retail investors probably just want to know one thing — how does this impact my portfolio…and, as a consequence, my future?
Morningstar’s big takeaway is that the impact of adding bonds to a portfolio is muted during periods like right now. Normally, bonds are used as a way to reduce risk and improve diversification. While the future of interest rates and inflation remain murky, though, this may not be as effective right now.
That isn’t to say that you should pull all your money from bonds and throw it all into the stock market; bonds can absolutely still be an important part of your strategy, the effectiveness of bond investment may be a bit lower impact for awhile.
How You Can Respond to Inflation
The most important thing you need to ask yourself during a period of high inflation is if your portfolio is at the very least keeping pace with the inflation rate. If you’re seeing 4% annual growth in your retirement portfolio, that may seem like a great outcome; if that rate is coupled with a 6% annual inflation rate, though, you’re actually losing 2% annually in value.
There are many investment options available that are designed to serve as a hedge against inflation. One of the most popular are Series I bonds, which have an adjustable rate that is pegged to inflation. You are limited in how many of these you can buy, but if you’re looking for an investment that will give you a guaranteed rate of return that should absolutely keep up with even the nastiest inflationary time, I bonds are worth considering.
The Bottom Line
Though it has slowed down a bit, the inflation rate is still relatively high. As in past time period with similar inflation rates, the correlation between stocks and bonds currently positive, meaning they go up and down value together. This makes bonds less useful as a way to diversify and protect your money.
- A financial advisor can help you make the most of your money. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Use SmartAsset’s free asset allocation calculator to see what your portfolios mix should look like.
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