In Part 1 of our guide to inflation we took a look at its causes, history, and current outlook. If you haven’t already done so it may be helpful to review before continuing.

At Cobblestone, we think about portfolios the same way in every inflationary environment. In order to meet their current and future spending needs, our clients’ portfolios need to grow at a pace that meets or exceeds inflation after withdrawals. Over time this allows for the purchasing power of the assets to be either maintained (in the case of investors who are already living off their assets) or increased (for investors who are not yet drawing on their assets). The expectation is that investors who are not yet drawing on their assets will be rewarded for forgoing current consumption by increasing the ability to consume in the future.

The bulk of most client portfolios are invested in globally diversified stocks. Over lengthy time horizons, equities have proven to be a very good hedge against inflation, better than some of the assets that are more commonly considered inflation hedges like gold or commodities. That’s because most companies can raise prices over time, which helps insulate their revenue stream from the impacts of inflation, while simultaneously reinvesting profits (or distributing profits in the form of dividends so that they may be reinvested elsewhere) to increase the value of the company. It is this value creation that is expected to provide for positive “real” returns over time. International equities can be an additional source of inflation protection for U.S. investors through the foreign currency appreciation that would likely follow an extended period of U.S.-centered inflation.

Additionally, client investments in alternative and private investments can act as good inflation hedges in that they are either unaffected or directly benefit from higher interest rates and/or the major inputs into rising prices. Take private real estate as an example. Owners of real estate can raise rents over time. This growing stream of rental income is what allows the real estate to support growing distributions and ultimately gets capitalized through higher exit prices when the real estate is sold.

It is true that, with interest rates where they are today, it is difficult to make the case that bonds will provide much protection in an inflationary environment. However, that’s not their job. Bonds are included in a portfolio for diversification and stability of principal, which is particularly important for investors that are living off their investments. Sacrificing the stability and diversification of traditional bonds in order to further protect against the long-term impacts of inflation is unnecessary at best and counterproductive at worst.

We don’t feel like investors should be doing anything differently in an inflationary environment, as long as the portfolio is already appropriately positioned for their circumstances. Outside of investment portfolios, there are a couple main things that individuals should consider. For most people, their home mortgage is their largest individual expenditure. Locking in low fixed-mortgage rates insulates that expense from increasing over time, which can be very powerful in an inflationary environment. Another example is deferring expenditures on big-ticket items with high rates of depreciation, like automobiles. Keeping your car for many years after it is paid off may not be the most enjoyable financial decision, but the ability to avoid having to keep paying for new, more expensive cars on a regular basis can be an important component of reducing the impact of inflation on your personal finances.

Inflation can’t be avoided, but with a solid investment strategy we can help clients minimize its impact on long-term financial plans.

For more than three decades, Cobblestone has been a trusted partner to individuals, families, and institutions. In the same way distinctive cobblestones are thoughtfully assembled to withstand any conditions, we provide the breadth of services, depth of expertise, and team approach required for resilient financial stewardship.
DISCLOSURE: Cobblestone does not provide tax or accounting advice; clients should also consult with licensed professionals in that field.
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