Stocks and Inflation Rate
Inflation can eat up a substantial part of your earnings. So, whenever the levels of inflation go out of control you should be very careful about the negative impacts it may have on your investments.
Inflation destroys the purchasing power of consumers due to the rising prices of goods and services. Economists commonly refer to it as having too much money that go after to few goods and services. As a result of the chase, the prices of the latter increase to very high levels.
Stock Prices and Inflation Rates
Generally, stocks are famous for their relative protection against inflation. This is so, since revenues and earnings generated from stocks rise at the same rate as inflation. However, in order for this to occur, the prices of shares should also increase. On the other hand, companies don't operate in a vacuum and they face the competition of global companies. The latter are subject to different inflation rates, so the rising prices in accordance to inflation rates is sometimes unachievable.
Additionally, when inflation is about to get out of control, the government may set the scene by increasing interest rates in order to curb the inflation. This is not good news for most companies, since the higher interest rates lead to lower spending on the part of consumers.
So, stocks are inflation protected only in case your portfolio fully consists of stocks and no other investments. However, since most investors are advised to diversify among different types of investments it is rarely the case that there is a portfolio including only stocks.
Most susceptible to the negative impacts of inflation are fixed income investments and cash. Additionally, inflation represents a serious threat to assets of investors preparing for their retirement or those who have just entered it. This is so, since their focus now is on transferring their assets to income generating investments that are susceptible to inflation effects. So, a good tactic followed by many retirees is the holding of a small percentage of their portfolio in stocks.
Final Piece of Advice
Our recommendation is not to make drastic changes to your investment portfolio when there is an alarm on increasing inflation rates. So, keep a close watch on your portfolio especially if you are nearing retirement and have to move your assets to fixed income securities. If there is truly a danger of high inflation rates, move a portion of your money to equities, which give a relative protection against the negative impacts of inflation.
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