Effects of Inflation on Your Investment Portfolio
Inflation represents one of the major threats to stock investors. When the inflation rates start to rise, investors get really nervous in expectation of the potentially negative consequences. Additionally, the Fed starts to look ways to prevent the negative impacts from the rising inflation.
Many industries wait for the response of the Fed for tactics of combating inflation. One of the alternatives is to increase interest rates.
However, the rising prices and the higher interest rates don't lead to positive effects on the investment portfolios of investors. Since the revenues and earnings of companies tend to rise at the same pace as inflation, then stocks provide protection to inflation to a significant degree.
Rising process can be transferred to consumers. However, the globalization of the market may lead to loss of competitiveness of companies that compete in the global arena. Since inflation rates are not the same in foreign countries the rise will not be reflected in the prices of foreign goods.
Inflation has another negative impact, namely the prices rise but no additional value is added. This means that your dollars lose purchasing power and as a result you buy less with the money you have than before.
Since revenues and earnings of companies rise at the same pace as inflation, their financials are overstated, since no additional value is created.
However, when the inflation starts to fall to its normal levels, the overstated earnings and revenues will decline as well. These ups and downs lead to blurring the actual state of value.
In order to combat inflation, the Fed usually uses short term interest rates. Since the interest rates are increased, it becomes more expensive to borrow money. As a result borrowing is discouraged, which leads to less money in circulation.
Generally, inflation is defined as having too much money going after too few goods and services. By discouraging borrowing and decreasing money in circulation, the Fed manages to decrease the amount of money that chases goods.
Inflation Effects on Investment Portfolios
If your investment portfolio includes a big portion of fixed income securities you should pay attention to inflation rates.
Most susceptible to rising inflation rates are retirees that have fixed income. This is so since inflation decreases the purchasing power of dollars and retirees will be able to purchase less with their money than before. So, many financial advisors recommend the inclusion of stocks as part of their investment portfolios since they protect against inflation.
Inflation will eat up the cash and cash equivalents that you hold. It is recommended to invest in Treasury I Bonds and other fixed income solutions that represent a hedge against inflation.
Therefore, you should be cautious about rising interest rates, since they can greatly damage your investments.
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