For the past decade, South Florida investors have had little reason to worry about inflation. Interest rates have remained at historically low levels. Mortgage rates have stayed down, and prices have been fairly stable for most goods and services.
But that situation could change in the next few years, and investors need to prepare for the potential consequences. That could mean rebalancing your portfolio holdings or adding new assets to address the risk of inflation.
Why is inflation a problem for investors? Unlike a sudden drop in the stock market or a drop in real estate prices, inflation has often been called a silent thief because it can rob your savings of their purchasing power.
Let’s say you have $10,000 in your money market or savings account — enough to cover several months of your household expenses. In a period of high inflation, your landlord might raise the rent, your commuting costs would go up, and you would need to spend more at the supermarket each week. While your savings might increase slightly in value due to higher rates, that benefit would likely be offset by a larger loss in its purchasing power.
Inflation is typically measured by changes to the consumer price index (CPI), so investors should keep a careful eye on the CPI in the coming months. After all, an increase in your out-of-pocket expenses for products and services, also make it more difficult to save money and invest for the future.
On the other hand, inflation can also trigger an increase in wages, salaries, and Social Security payments. It may also spur banks and other financial institutions to raise their rates on certificates of deposit (CDs), as well as savings and money market accounts. As a result, you might feel you are better off than before, even if a wage increase is only enough to match the higher CPI.
A growing concern
There are three primary reasons investors are increasingly concerned about higher inflation. First of all, the U.S. labor market is extremely tight with an unemployment rate of just over 4 percent. That means employers are feeling more pressure to increase their wages and salaries to hire and retain good workers.
In turn, higher wages and salaries may encourage sellers of consumer goods — from groceries to electronics to automotive parts — to raise their prices as well. If your income hasn’t increased as well, you’ll find yourself having to stretch each dollar further than before.
A second reason for concern is President Donald Trump’s decision to impose tariffs on imported steel and aluminum. Imposing tariffs would increase the prices for a wide range of consumer goods, such as automobiles, refrigerators and soup cans, depending on how and when the president’s policy is implemented. Other manufacturing industries, that use imported metals, including aviation and electronics, might also have to raise their prices.
A potentially bigger issue is that other countries affected by the new U.S. tariffs would retaliate with their own tariffs, which could increase the prices of foods, gasoline, electronics and other types of products. Regardless of which country "wins" a trade war, consumers are likely to wind up paying more out of their pockets.
Finally, the Tax Cuts and Jobs Act of 2017, which made significant changes to the nation’s tax code, may also lead to higher inflation in the next few years. That’s because the act may result in a sizable increase in the U.S. government’s deficit. If the federal government needs to borrow more money, it will likely have to pay a higher interest rate on its Treasury bills, savings bonds and other financial securities.
Suggestions for investors
In light of the rising risk of inflation, investors should talk with their financial advisors about adjusting their portfolio allocations. One suggestion is to examine your exposure to fixed-rate bonds with long maturities, whose underlying value may decline in an inflationary scenario. If you like holding bonds, you might consider TIPS (Treasury inflation protected securities), whose rates can rise based on changes to the consumer price index.
You should also look at the other assets in your portfolio to see how they might respond to inflationary pressures. Unlike bonds, some stocks and real estate assets can perform well in times of inflation. Do some research and talk with your advisor about potential strategies.
Remember that U.S. and global financial markets are constantly changing. While it’s easy to read the daily headlines, it’s also important to look at the underlying trends like inflation when making your decisions.
Andrew Menachem, CIMA®, is a Wealth Adviser at The Menachem Group at Morgan Stanley in Aventura. Views expressed are those of the author, not necessarily Morgan Stanley, and are not a solicitation to buy or sell any security. The strategies and/or investments referenced may not be suitable for all investors. Follow Menachem on Twitter @AMenachemMS